Eurozone inflation fall intensifies
Eurozone HICP flash inflation took a renewed leg lower in May, with headline inflation falling to 1.9% from 2.2% in April, and core inflation falling to 2.3% from 2.7%. Within that, services inflation fell sharply to a three year low of 3.2%, down from 4% in April.
On a seasonally adjusted basis services inflation posted the first negative m/m reading since the onset of the energy crisis in 2022 – marking a return to more normal price dynamics when services prices would occasionally fall on a monthly basis. Part of the decline was expected and due to an unwind of the Easter boost to travel and hospitality pricing , but the fall was even bigger than both our and consensus expectations. The other big driver of headline inflation continues to be energy, which fell for a fourth consecutive month and is now running at -3.6% y/y – reflecting both the fall in oil and natural gas prices, but also the recent strength in the euro. Goods inflation remains contained at a subdued 0.6% y/y, while the recent manufacturing PMI suggests waning price pressures with the input price sub-index falling back below 50 in May.
Looking ahead, while there is likely to be some rebound in services inflation in June, in big picture terms the downtrend in core inflation is firmly established. Although underlying wage growth remains somewhat on the high side, the data shows that businesses are absorbing more of this into their margins, reflecting a somewhat subdued demand environment for services but also likely the expectation that wage growth will continue to normalise in the course of the year. Both the ECB’s forward-looking negotiated wages tracker and the Indeed monthly tracker for new vacancies suggest that wage growth will be back at levels consistent with the 2% target by the end of this year. See our recent note for more.
Case for ECB cuts even clearer
All in all, the ECB will be pleased with today’s data and what it portends for the future, as it makes the case for further rate cuts more clear. At this Thursday’s meeting we expect ECB staff to significantly downgrade inflation projections and more modestly downgrade growth projections. Both are likely to pave the way for a continuation of rate cuts. Beyond Thursday’s expected 25bp cut, we expect an additional two rate cuts by September, ultimately taking the deposit rate to 1.5%.