Rate cut expected as eurozone inflation falls

The prospect of a eurozone interest rate cut has excited investors, with many predicting the European Central Bank, or ECB, will now slash borrowing costs by a quarter of a point.

The optimism followed news that inflation fell during August within the 20-member bloc that uses the euro for currency, to a three-year low of 2.2 percent, after having edged up in July to 2.6 percent from 2.5 percent in June.

Bert Colijn, an economist at ING, told the Financial Times newspaper the fact that Eurostat, the European Union's official statistics agency, declared the eurozone's inflation rate to be within a whisker of the ECB's target of 2 percent means rate cuts will be likely when the bank discusses the issue on Sept 12.

"The inflation environment is slowly getting more benign," Colijn said. "The ECB has arrived on a long home straight."

Eurostat said Germany and Spain reported bigger than expected falls in consumer price rises in August, while France also did well, recording inflation at 2.2 percent in spite of cost pressures associated with hosting the Olympic Games.

If the ECB does reduce its key interest rate by a quarter-point to 3.5 percent, it will follow on from a quarter-point cut in June and could lead to more cuts, with the Financial Times saying traders are now hoping for two or three additional quarter-point reductions before the end of the year.

However, within the overall inflation rate, there was a worrying uptick in the cost of services, something that Jack Allen-Reynolds, from Capital Economics, told the Financial Times may cause concern at the bank.

"However, we doubt that August's unexpected increase in services inflation will stop the ECB from cutting interest rates at its next meeting in September," he told the paper.

A 3 percent fall in the cost of energy during August more than offset the increase in the cost of services.

Core inflation, which ignores price changes in volatile commodities including alcohol, energy, food, and tobacco, stood at 2.8 percent in August, according to Eurostat, down slightly from 2.9 percent in July.

French newspaper Le Monde said the ECB is likely to look closely at the core inflation rate when setting its interest rate, and this could mean interest rate cuts are far from certain.

The ECB started its campaign of aggressive interest rate hikes in July 2022, when the eurozone's inflation rate was rocketing up to 10.6 percent in October, largely because of fast-rising energy and food costs attributed to the Ukraine conflict.

Sam Miley, from the London-based Centre for Economics and Business Research, told Le Monde that interest rate cuts are more likely now than they were a few weeks ago, but are not guaranteed.

"The … rate of core inflation and continually tight labor market will present risk factors to implementing looser monetary policy," Miley said.