ECB still likely to cut in September, despite sticky eurozone services inflation

The higher than expected June core HICP outturn leaves the average for Q2 at 2.8%, which is slightly higher than the 2.7% that the ECB expected in its June projections. On the ECB’s seasonally adjusted measure, June inflation looked more benign, with headline prices rising just 0.1% m/m, and core rising 0.2%. The strength continues to be entirely in services, which – against our expectations for a decline from the firm May reading – held steady at an elevated 4.1% y/y (we had expected a decline to 3.9%). In contrast, all other main components of inflation look benign or even weak: 1) energy continues to surprise to the downside, reflecting lower petrol prices but also suggesting there might be more unrealised pass-through from the collapse in gas and electricity prices than is generally assumed (recent PPI developments also points to this); 2) food inflation continues to normalise (at 2.5% in June it was the lowest since November 2021); and 3) goods inflation has been running below 1% the past three months.

Services inflation should ease in the near term, but stay elevated

We will have to wait until 17 July for the full details of the June data, but we suspect that labour-intensive services remains elevated, and this is offsetting disinflation in energy-intensive services. Historically, labour-intensive services inflation moves broadly in tandem with the ECB’s negotiated wages measure. The latter is expected to stay high for a time – a rather backward-looking consequence of workers seeking a correction for the inflation hit to real incomes. This factor is therefore likely to keep upward pressure on services inflation in the near term. However, even with this upward impact, we still expect overall services inflation to move lower, helped by the continued decline in energy-intensive services, which is still seeing pass-through from the collapse in energy prices over the past 18 months.

ECB still looks set to cut in September

Given that the ECB itself expects services inflation to gradually ease but to stay on the elevated side over the coming months (implicit in its June core HICP forecast), this will not be a barrier by itself to further rate cuts – provided the ECB has confidence in the inflation outlook. Indeed, in an interview with Bloomberg this morning, ECB Chief Economist Philip Lane said the incoming June data “seem to be in line with the ECB assessment” while also continuing to signal room for further rate cuts. GC President Lagarde also said “we don’t need services inflation at 2%.” Provided that more forward-looking wage measures (such as the Indeed monthly tracker) continue to point to moderation, and that other measures (such as the negotiated wages measure) do not surprise significantly to the upside, we continue to think the Governing Council will be confident enough in the inflation outlook to resume rate cuts in September, after a pause in July.