Eurozone inflation rose last month but remained on track, allowing the European Central Bank (ECB) to cut interest rates further, even as the US dollar’s rally, trade war threats and rising gas prices added to uncertainty.
The ECB cut borrowing costs for the fourth time in a row last week and signalled further easing as inflation is expected to return to its 2% target by the end of the summer, weak economic growth and the risk of a trade war loom.
Consumer price inflation in the 20 countries that use the euro rose to 2.5% in January from 2.4% in December, slightly above expectations of 2.4% in a Reuters poll, as a sharp rise in energy costs added to price pressures.
However, core inflation, a key indicator of the resilience of price growth, held steady at 2.7% and services sector inflation eased. This provides some relief to the ECB, which has long argued that domestic price pressures remain too high, although there are signs that they could ease with slower wage growth.
For now, even with the US dollar’s continued rise, the impact may not be large enough to change expectations about borrowing costs.
The ECB has previously estimated that every 1% decline in the euro would increase inflation by 0.04% over a year. However, on a trade-weighted basis, the euro has only fallen by around 2% since the US election in November, suggesting a small overall impact.
While the rise in inflation is not expected, the figure is in line with expectations outlined by ECB President Christine Lagarde, who said last week that price growth is likely to hover around this level before gradually easing towards its 2% target over the coming period.
The debate over a possible pause in policy easing is likely to only intensify in April, when the deposit rate could hit 2.5%, the upper end of the estimated range for the “neutral” level, a rate that neither hinders nor stimulates economic growth.
Tariffs slow economic growth because they reduce demand for European goods abroad, hurting exports that have been a key driver of growth for decades. However, countermeasures could increase domestic inflation by making imported goods from the US more expensive.
