Falling euro zone inflation could boost rate cut bets

Data from the European Union’s statistics office showed on Tuesday that consumer price growth in the 20-nation euro zone slowed to 2.2% in March from 2.3% in February, in line with expectations in a Reuters poll, as energy costs fell sharply and inflation in the services sector slowed.

The closely watched core data, which excludes volatile food and fuel prices, slowed to 2.4% from 2.6%. That was below expectations for a 2.5 percent rate, which could be a relief to the ECB, which has long worried that underlying price growth is unsustainable.

The ECB has cut interest rates six times since June last year. With the economy still stagnant, energy prices retreating and the euro surging, investors are increasingly confident the European Central Bank will cut interest rates again on April 17. At the same time, the recent rise in long-term yields has also offset some of the ECB's past efforts to lower borrowing costs.

While a looming trade war with the United States poses a fundamental threat to the eurozone economy, recent signals from the ECB suggest inflation concerns remain subdued.

Tariffs and inevitable retaliation would slow growth and push up prices, threatening to create an environment of high inflation and stagnation, commonly known as stagflation.

But ECB Vice President Luis de Guindos said last week the hit to growth from the rate cut was so big it would essentially eliminate additional price pressures and would have only a "transient" impact on prices.

European Central Bank President Christine Lagarde said the trade war could shave 0.5 percentage points off eurozone economic growth, a huge blow considering the eurozone as a whole grew just 0.9% last year.

The increase in service prices slowed to 3.4% from the 3.7% many policymakers had forecast as expectations of rate cuts grew.

The services sector has become a headache for policymakers over the past year as inflation hovers around 4% for almost all of 2024, challenging the argument that slower wage growth is slowly removing price pressures.

However, food price inflation accelerated further as the cost of unprocessed food rose 4.1%.

The ECB said last month it expected inflation to hover around current levels for the rest of this year and fall to its 2% target by early 2026. But some believe that recent changes in financing conditions suggest the date for a decline in inflation will be brought forward.

Although the April rate cut is far from a done deal, policy doves have called for a rate cut, while hawks have been more silent and may request a pause in rate cuts.

One potential concern could be that the labor market remains tight. Separate data from Eurostat on Tuesday showed the unemployment rate fell to a record low of 6.1% in February.

Markets are currently pricing in a 70-75% chance that the ECB will cut its 2.5% deposit rate in April, with a June rate cut more than fully priced in. Interest rates are expected to fall further in 2025, with investors expecting deposit rates to bottom out at 2.00% or 1.75% at the start of the year.