Euro inflation drops ahead of likely rate cut

INFLATION across the Eurozone dropped in May, according to official figures released yesterday, giving the European Central Bank (ECB) its last price data before a major decision on interest rates tomorrow.

Consumer prices in the Eurozone rose by just 0.5 per cent in the year to May, the joint-lowest increase since 2009. Inflation was similarly muted in March, but was distorted in that month by the effect of a later Easter.

The ECB is widely expected to cut interest rates again this week, pushing their benchmark rate into negative territory for the first time ever.

Even Germany’s harmonised consumer price index dropped by nearly half between April and May, from a 1.1 per cent rise to just 0.6 per cent. The powerhouse economy has previously seen more price pressure than peripheral countries.

When broken down into its components, services added almost all the pressure on European prices over the last year for the currency bloc, with an increase of 1.1 per cent. Food, tobacco and alcohol prices nudged upwards by only 0.1 per cent in the same period, and energy prices stayed completely flat.

“The European Central Bank looks set to react by loosening policy this week, with a cut in interest rates and measures to boost bank lending. But more decisive action is likely to be needed, including a programme of quantitative easing and perhaps direct intervention to lower the euro exchange rate,” said Jonathan Loynes of Capital Economics.

Other economists expressed further scepticism that tomorrow’s action will have a particularly useful effect.

“The moves by the ECB have been widely trailed and markets are fully positioned. Moreover, once the announcements have been made, the market may begin to ponder on how effective they will be. European rates are already very low; the scope to push them down further is limited,” said Steven Bell of F&C Investments.