Consumer prices in the eurozone increased by 2.2% year over year in April, according to Eurostat’s flash estimate, the same as March’s reading, and above expectations.
But core inflation, which shows prices without volatile components such as energy and food costs, rose 2.7% year over year in April, up from 2.4% in March, surprising on the upside.
“European inflation remained flat at 2.2% in April, above forecasts, but still almost in line with the European Central Bank’s targeted level,” said Michael Field, chief equity market strategist for Europe at Morningstar. But “any level of comfort we have here is precarious” because of the risk of US tariffs.
“Disappointingly, core inflation rose to 2.7%, having dipped in Feb and March. This moves us further away from the ECB’s 2% target level,” Field says.
Service Inflation Ticked Up, Energy Prices Down
According to Eurostat’s estimates, services saw the highest annual rise in April at 3.9% year over year, higher than March’s reading of 3.5%. Food, alcohol & tobacco inflation increased by 3%, compared with 2.9% in March, meanwhile nonenergy industrial goods was stable at 0.6%, and energy slowed down at 3.5%, compared with a 1% slowdown the previous month.
Riccardo Marcelli Fabiani, senior economist at Oxford Economics says that the timing of the Easter drove services inflation up. “This and food edging up offset energy inflation falling deeper into negative territory,” he adds.
According to Marcelli Fabiani, the rise in core inflation “should not cause concern due to the temporary nature of the services uptick, and the outlook becoming less inflationary”. Dropping oil prices and a stronger euro will drag down energy inflation and lead to cheaper production inputs and imports. Moreover, he adds that the hit to demand will weigh down core inflation and accelerate the easing of wage growth.
On a monthly basis, headline inflation (HICP) increased by 0.6% in April, the same as in March, meanwhile core inflation was up 1%, like in March.
How Does a Stronger Euro Affect Eurozone Inflation?
The euro has strengthened by about 10% against the dollar since the beginning of the year. According to Goldman Sachs, a 1% broad euro appreciation lowers headline HICP and real GDP by around 0.1% each. The effects on core HICP are negative, too, but half the size of the headline inflation.
“We find that around 75% and 50% of the cumulative effects of a stronger euro on headline and core inflation materialize within a year, respectively,” the investment bank said in a report on May 2, adding the euro’s appreciation so far will probably subtract 0.1-0.2 percentage points from year-over-year core inflation in each of the next two years. “Further euro appreciation would imply a larger and more persistent drag on inflation.”
However, in the short term, inflation could move sharply upward again in Europe, if there will be an escalation in the trade war. “The EU is currently formulating a response to Trump’s most recent round of tariffs. Shrewdly, they are waiting until the end of the 90 day pause, but any further escalation would see inflation moving sharply upward again in Europe,” says Morningstar’s Field.
Will the ECB Cut Rates in June?
The next European Central Bank’s monetary policy meeting will take place in Frankfurt on June 5, and markets expect that the easing cycle will continue amid economic headwinds. The ECB cut its key interest rate by 25 basis points to 2.25% on April 17, the sixth consecutive reduction in this cycle.
Goldman Sachs sees three more interest rate cuts this year in June, July and September to a terminal rate of 1.5%, because the euro’s appreciation this year “is large by historical standards, disproportionately skewed towards the dollar, and largely the result of external drivers”. Terminal rate refers to the point where a central bank stops cutting or raising rates in the cycle, and usually coincides with inflation being at target.
Morningstar’s Field agrees on the likelihood of more ECB cuts: “This relatively low level of headline inflation keeps the pressure off the ECB, who can in turn lower interest rates further. Lower interest rates are a boon to equity markets, which we believe still offer attractive upside potential following the April 2 induced crash.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
