Eurozone consumer prices rose 2.6% year-on-year in May, according to a preliminary Eurostat estimate, from 2.4% in April and beating economists' expectations. It was the first month-on-month increase in 2024. Core inflation, which measures prices excluding energy and food costs, also rose to 2.9% year-on-year from 2.7% in April.
According to Eurostat estimates, the largest contributor to euro area inflation in May was services (4.1%, up from 3.7% in April), followed by food, alcohol and tobacco (2.6%, down from 2.8% in April), non-energy industrial products (0.8%, up from 0.9% in April) and energy (0.3%, up from -0.6% in April).
Could rising inflation jeopardize the ECB's rate cut plans?
“The stronger-than-expected inflation reading in May will worry some investors, particularly as it was services inflation that drove the increase in inflation, an area the ECB has previously expressed concerns about. While such an increase is unsettling, we see no reason to panic, especially after successive declines,” said Michael Field, European market strategist at Morningstar.
He said there are three things to keep in mind.
- “First, and most importantly, inflation is never going to fall in a perfectly linear fashion to the ECB's 2% target. The ECB had previously projected inflation to fall to 2.3% by the end of the year. It is now at 2.6% and with seven months left in the year, there is plenty of time for inflation to fall further.”
- Inflation rates varied widely across the euro area in May, with Belgium's inflation rising to nearly 5% and Italy's at less than 1%. This difference simply highlights that labour market tightness is country-specific and not a euro area-wide trend, making further increases in inflation unlikely as the year progresses.
- “Core inflation, the ECB's most closely watched measure, rose 20 basis points in May but remains at less than 3%, almost half of what it was at the same time last year. There may be challenges ahead, but we have come a long way and the trend is still downwards.”
Eurozone bond yields rose slightly after the release of the pricing data. German 10-year bond yields rose 0.048% to 2.7% (Source: MarketWatch). Italy's BTP yield was at 3.49% (Source: Borsa Italiana). Equity markets were mixed at midday.
The pace of ECB rate cuts beyond June remains unclear
The European Central Bank (ECB) will hold its monetary policy meeting on June 6th, with markets expecting an interest rate cut.
“A further small fall in inflation in May would have supported a rate cut, but with more than 90% of economists surveyed expecting the ECB to cut rates in June, it is highly unlikely that such a small rise in inflation would be enough to prevent a rate cut,” Field said.
But the path forward is unclear: “There is significant uncertainty about the pace of deflation,” UBS economists wrote in a May 28 note.
European Central Bank (ECB) President Christine Lagarde said the ECB's monetary policy remains highly data-driven and is not committed to a “particular interest rate path”.
UBS economists forecast a 75 basis point cut this year and 100 basis points in 2025. “Our central scenario sees the ECB cut rates for the first time in June, followed by 25 basis point cuts per quarter over a longer period… We see the repo rate reaching 3.25 by the end of 2024 and 2.25 by the end of 2025.”
