Confirmed Euro Zone Inflation Fall Bolsters ECB's June Rate Cut Plan

KONTAN.CO.ID - FRANKFURT. Euro zone inflation slowed across the board last month, reinforcing expectations for a European Central Bank interest rate cut in June, even as rising energy costs and a weak euro cloud the outlook, final data from Eurostat showed on Wednesday.

Inflation in the 20 nations sharing the euro currency slowed to 2.4% last month from 2.6% in February, in line with a preliminary estimate released earlier this month.

Meanwhile underlying price growth, which filters out volatile food and energy prices dipped to 2.9% from 3.1%, despite services inflation holding steady at an uncomfortably high 4.0%.

Inflation has fallen quickly over the past year, opening the way for interest rate cuts starting in June, even if the next few months are likely to bring choppy price growth data and a drawn-out return to the 2% target.

The euro zone is facing opposing inflationary forces, which could keep the headline rate fluctuating around current levels over the coming months before dipping towards 2% in the autumn.

Factors pulling inflation down include the continued slowdown in wage growth, anaemic demand given a near recessionary environment, tightening fiscal policy, cheap imports from China and relatively low gas prices after a mild winter.

But rising oil prices and a weaker euro both put upward pressure on prices while stubborn services costs raise the risk of underlying price growth getting stuck above target.

"The recent rise in commodity and energy prices will add to headline (inflation) in the coming months, with euro/dollar weakness sponsored by Fed-ECB policy divergence compounding the move," TS Lombard said in a note.

"The euro area remains among the largest energy importers worldwide, with great sensitivity to energy prices."

The euro has weakened around 4% against the dollar since the start of the year and the movement has been exacerbated by expectation for slower rate cuts by the U.S. Federal Reserve given sticky inflation.

But this is mostly a move in the dollar, not the euro, economists says, and the trade weighted euro has weakened much less, muting the impact of exchange rate movements.

"For the time being, the weaker euro doesn't look like the biggest concern for the ECB," ING said in a note. "It is rather the surge in oil prices and a potentially further escalation of the conflicts in the Middle East that will give at least the ECB hawks some headaches."

Policymakers have so far said that the oil price and exchange rate moves are too small to fundamentally alter the inflation outlook but market expectations for ECB rate cuts continue to retreat.

Investors now see only 75 basis points of rate cuts this year, or two moves after June, a retreat compared to two months ago when between 4 and 5 cuts were seen.

Energy has been a big drag on inflation all year as high year earlier figures get knocked from base figures but this trend could reverse in the second half of the year, if oil keeps going up.

Some argue, however, that the traditional link between oil and gas prices has been broken so an oil price rise does not automatically lift natural gas prices and does not have the same upward impact on inflation as in the past.