Euro zone inflation accelerated slightly last month but remained on an anticipated course that could allow the European Central Bank to cut interest rates further, possibly as soon as March.
The ECB lowered borrowing costs for the fourth straight time last month and hinted at even more policy easing since inflation could be back at its 2% goal by late summer, economic growth is anaemic and a trade war with the U.S. was a distinct possibility.
Consumer price inflation in the 20 nations sharing the euro accelerated to 2.5% in January from 2.4% in December, Eurostat said on Monday, just above expectations in a Reuters poll of economists, as sharply higher energy costs added to price pressures.
However, underlying inflation, a valuable indicator of the durability of price growth, held steady and services inflation eased. That was a modest relief to the ECB which has long argued that domestic price pressures are too high, even if all conditions are in place for some easing in those pressures given more muted wage growth.
Price growth excluding volatile food and energy was unchanged at 2.7% and the closely watched services component, the single biggest item in the consumer price basket, eased to 3.9% from 4.0%.
While quicker inflation is not welcome, the figures are in line with the narrative outlined by ECB President Christine Lagarde, who last week said that price growth could oscillate around these levels for the coming months before a slowdown towards the 2% target in the subsequent period.
This benign path is a key reason why markets anticipate at least three more rate cuts this year and why policymakers speaking both on and off the record consider a March move very likely. The debate on a possible pause is only set to heat up from April by when the deposit rate could be at 2.5%, the upper end of the estimate range for the ‘neutral’ level, a rate that neither restricts, not stimulates growth.
The biggest risk to such an outlook is whether U.S. President Donald Trump levies fresh tariffs on the European Union and how the bloc responds.
Tariffs slow economic growth since they reduce demand for European goods overseas, weighing on exports, a key driver of growth for decades. But retaliatory measures could push up domestic inflation by making goods imported from the U.S. more expensive. Tariffs also change the outlook for monetary policy and put subtle pressure on inflation via the exchange rate.
Trump’s policies could delay Fed rate cuts, increasing the interest rate differential on the two sides of the Atlantic, firming the dollar as investors move into higher yielding U.S. assets. This will make imported goods, especially energy, which is priced in dollars, more expensive, countering the deflationary impact of weak economic growth.
