Euro zone inflation and growth fall as ECB hikes bite

By Francesco Canepa

FRANKFURT (Reuters) – Inflation in the euro zone is falling fast and the economy has begun contracting, data showed on Tuesday, illustrating the dual impact of a steady diet of European Central Bank interest rate hikes.

Prices rose by just 2.9% in October, their slowest pace since July 2021, a Eurostat flash reading showed, a time when the ECB was still worried about inflation getting stuck below its 2% target.

But the brisk decline from double-digit figures just a year ago is coming at a cost: the euro zone economy shrank by 0.1% in the three months to September, according to a separate Eurostat release, and is flirting with a recession.

The two sets of data mean the ECB has almost certainly finished raising interest rates, which are at record highs after an unprecedented streak of 10 consecutive hikes, and will now watch their impact play out before making further moves.

“We expect a plateau in rates at current levels, in the context of slowing inflation and economic growth, followed by cuts from the middle of next year,” said Daniele Antonucci, chief investment officer at Quintet Private Bank.

Later on Tuesday, Greek central bank governor Yannis Stournaras became the first ECB policymaker to talk about a possible rate cut towards the middle of next year if inflation were to stabilise below 3%.

His more hawkish German colleague Joachim Nagel, however, would not rule out more hikes, while France’s Francois Villeroy de Galhau, seen as a centrist, said rates should stay “at their current level” for as long as needed.

BASE EFFECTS

Headline inflation started falling sharply last month as the massive increase in energy prices recorded a year earlier set a higher “base” for the annual comparison – an effect set to fade or even reverse in upcoming readings.

A measure of inflation that excludes energy, food, alcohol and tobacco recorded a more moderate decline, to 4.2%, the lowest level since July 2022, from 4.5%.

While all components in the inflation basket increased by less than a month earlier, the slowdown was minimal in services, at 4.6% from 4.7%, probably as a result of rising wages.

“The ECB needs to see wage inflation slowing and this could take a further six months,” Deutsche Bank economist Mark Wall said.

HARD LAST MILE

The last mile may well prove the hardest, however, with inflation not seen returning to the ECB’s 2% target until 2025 even on its own numbers.

“It’s now down to weaker demand grinding down inflation and that’s a slow process,” Natixis’ economist Dirk Schumacher said.

It is a painful one too, with gross domestic product across the 20 countries that share the euro expected to continue contracting in the final quarter.

Tuesday’s reading was skewed by a 1.8% fall in Irish GDP, which is volatile and often subject to revisions relating to its large multinational sector.

But economists generally agreed it marked the start of a shallow recession in the euro zone, which may be aggravated by the armed conflicts taking place on Europe’s doorstep in Ukraine and in Gaza.

“It does look like the economic environment is weakening at the moment, but no sharp recession is in sight either,” ING economist Bert Colijn said.

“Still, continued economic and geopolitical uncertainty alongside the impact of higher rates on the economy will weigh on economic activity in the coming quarters.”

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