Falling German and French inflation fuels hope of interest rate cuts

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Falling inflation in Germany and France added to investors’ hopes that the European Central Bank will cut borrowing costs soon — even though rapid wage growth triggered a rise in services prices at the start of the year.

Consumer prices in Germany rose 3.1 per cent in the year to January, according to data published by the federal statistical agency on Wednesday. That was a slowdown from 3.8 per cent in December and below the 3.2 per cent forecast for January by economists in a Reuters poll.

A similar trend in French inflation, which fell to a two-year low of 3.4 per cent at the start of the year, has given investors hope that the ECB could start cutting its benchmark deposit rate from the current record high level of 4 per cent by April.

Price pressures have eased rapidly since Russia’s invasion of Ukraine and the lifting of coronavirus lockdowns triggered Europe’s biggest surge in the cost of living for a generation.

The two largest eurozone economies both reported sharply lower inflation in energy and goods, but they also had jumps in labour-intensive services prices. This is likely to worry ECB rate-setters who have said they want to see wages moderating before lowering borrowing costs.

Markets reacted by sending German two-year government bond yields down 0.08 percentage points to 2.44 per cent on Wednesday, with declines boosted by cooler than expected US jobs data. Investors think the fall in inflation makes it more likely the ECB — which targets 2 per cent inflation — will cut rates by April.

“There’s still one more inflation release to take into account before the ECB’s March meeting but the numbers for January make us more confident in our forecast that the first rate cut will be in April,” said Andrew Kenningham, an economist at consultants Capital Economics.

Joachim Nagel, president of Germany’s central bank and one of the more hawkish members of the ECB’s rate-setting governing council, added to these hopes by telling an event in Berlin on Tuesday before the latest data was released that he was “convinced that we have tamed the greedy beast [of inflation]”.

Price data for the eurozone to be published on Thursday is expected to show inflation in the single currency bloc slowed to 2.8 per cent in January — down from 2.9 per cent the previous month.

ECB president Christine Lagarde, however, sounded a note of caution on inflation and the prospect for rate cuts. “We are not there yet [on inflation]. We need all sorts of data, one of which is critically important,” she said in an interview with CNN broadcast on Tuesday night, saying. “It’s the data concerning wages.”

The ECB has forecast wage growth will slow from 5.3 per cent last year to 4.8 per cent this year and several policymakers have said they want to see evidence from this year’s collective wage agreements with unions that labour costs are moderating.

Germany’s core rate of annual inflation, excluding more volatile energy and food prices, inched down to 3.4 per cent. Services prices, however, accelerated slightly to rise 3.4 per cent in January.

French inflation in January fell 0.7 percentage points from December but was still slightly above economists’ forecasts of 3.3 per cent.

Insee, the French statistics agency, said energy inflation slowed sharply to 1.8 per cent, as did goods inflation to 0.7 per cent. Food price growth decelerated to 5.7 per cent. But services prices that make up half the inflation basket accelerated slightly to 3.2 per cent and tobacco prices moved sharply higher.

The IMF said on Tuesday that inflation was falling “faster than expected” in much of the global economy, allowing central banks to start lowering borrowing costs, which it said might be needed in some parts of the world to “avoid protracted economic weakness” and an undershooting of inflation targets.

Figures released on Tuesday showed the eurozone economy was underperforming most of the world after the bloc’s gross domestic product stagnated in the fourth quarter and expanded only 0.5 per cent over the whole of 2023. The US grew 2.5 per cent last year and China estimated its annual growth was 5.2 per cent.

Additional reporting by Mary McDougall