Euro zone inflation rises to 2.6% in May, but bloc still seen heading for interest rate cut

Inflation in the euro zone rose to 2.6% in May, statistics agency Eurostat said Friday, but a higher-than-expected print did not sway market bets of an interest rate cut from the European Central Bank next week.

Economists polled by Reuters had forecast a 0.1 percentage point increase from April’s headline figure of 2.4%.

Core inflation, excluding the volatile effects of energy, food, alcohol and tobacco, increased to 2.9% from 2.7% in April. A Reuters poll of economists had projected a flat reading.

The data comes with the ECB widely expected to cut interest rates at its June 6 meeting, the first reduction since 2019. The central bank for the 20-nation euro area began its latest hiking cycle in July 2022, hauling rates out of negative territory to 4% at present.

Any deviation from a 25 basis point cut at the ECB’s June meeting would be a major shock to markets, following weeks of strong signalling from policymakers.

In the wake of the reading, money markets continued to fully price in a June cut, followed by just one more reduction in 2024.

While headline inflation increased in May, fluctuations in the rate have been forecast over the coming months due to base effects from the energy market and the unwinding of government fiscal support schemes across the bloc, .

Overall, the headline figure has cooled significantly from a peak of 10.6% in October 2022, languishing below 3% for the past eight straight months.

However, ECB members may pay greater attention to the rate of services inflation — a key indicator of domestic inflationary pressures — which rose to 4.1% from 3.7%.

Staff are also due to release their latest round of inflation and growth projections at next week’s meeting, providing more clues on the pace and level of potential cuts this year.

ECB voting member Klaas Knot said earlier this week that the next phase of disinflation would be “more volatile,” and that monetary policy would need to be eased slowly and gradually to avoid inflation expectations de-anchoring from forecasts.

Kamil Kovar, senior economist at Moody’s Analytics, said in a note on Friday that the inflation print was likely “the last small bump in the disinflationary road rather than the beginning of any arduous last mile.”

He added, “Still, hopes for a July cut are buried very deep now, and based solely on data from recent weeks the ECB would not be cutting in June either. If rates are lowered in June this would be due to the building of momentum for a cut throughout the last nine months.”

The euro was slightly higher against the U.S. dollar and British pound at 11:30 a.m. in London, holding on to gains from earlier in the session.