Supporting economic recovery is now the main concern for policymakers in Europe, as Eurozone inflation remained low at 2.1% in August, marking continued progress in bringing price growth under control.
If the disinflation path continues, there is scope for up to two more ECB cuts before the end of the year — though the ECB will want firm evidence that inflation expectations remain securely anchored before committing to further moves.
Taking interest rates down to 1.5% would be a drastic measure to combat the bloc’s economic woes, but lowering rates is not a silver bullet. The European economy is being held back by deeply embedded structural challenges in areas such as government debt, employment, defence expenditure, and energy costs. These are not cyclical issues that can be wholly managed by an astute central bank.
Nonetheless, inflationary trends are promising and may push the ECB to take this decision. Falling wholesale gas and oil costs remain a major force pushing the headline rate lower, and core inflation in the Eurozone remains low, with underlying pressures in services showing signs of cooling.
While wage growth in these sectors continues to keep inflation stickier than in goods, the overall direction of travel is downward. Food prices are rising at a slower pace, offering some relief to households who have faced persistent cost-of-living pressures over the past two years.
Yet, the ECB must not be too complacent on inflation. Risks to inflationary pressures still remain from volatile energy markets, wage settlements, and ongoing global trade tensions. An overly ambitious rate-cutting strategy from here may threaten greater risk than its potential reward.
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