Global Monday Buzz: Euro Zone’s inflation cools faster than expected as oil prices fall — What this means for ECB's next move?

Despite earlier predictions and forecasts of Europe’s inflation rates increasing from its previous months, the overall inflation in the 21 nations sharing the ‌euro currency slowed to 2.8% in June, down sharply from 3.2% in May. Core inflation (excluding food and energy) also eased to 2.4% from 2.6%, far below numbers seen after the Israel-Iran war first disrupted markets. The key driver of this fall was energy prices which slowed down to 8.7% YoY from a height of 10.8% in May as a result of stabilizing oil prices with the easing situation of the Middle East supply concerns.

A broad-based slowdown across the bloc

It is worth noting that there has been a spread in disinflation across the Eurozone with Germany experiencing a 2.3% inflation in June from its 2.6% in the previous month. The Federal Statistical Office of Germany attributes much of this drop to fuel-duty cuts introduced to reverse the war-driven price spike which resulted energy inflation dropping from 6.6% to 3.4% in June. France also experienced a similar trend with its June inflation slowing down to 2.0% from 2.8% well below the 2.3% forecast. INSEE and AFP point these numbers to lower energy costs “after oil prices retreated amid easing concerns over Middle East supply disruptions,” with services inflation also cooling to 1.8%.

However, Spain inflation for June held flat at 3.6% unchanged from May with core inflation also remaining sticky indicating that underlying price pressures have not reduced completely. For Spanish households, the steady inflation rate means that purchasing power remains under strain, especially for lower-income families. The steady price pressure could keep European Central Bank (ECB) on alert and maintain pressure on household budget.

What this means for the ECB’s July 23 rate decision

ECB recently delivered its first-rate hike since 2023, in June due to expectations of further energy shock to spill over into broader inflation. However, with the most recent inflation numbers, Reuters reported that multiple policymakers, on and off the record have said “there’s no rush” for another hike in July following June’s quarter-point rate hike, despite June’s inflation reading still staying well above the ECB’s 2% target. The ECB is concerned that the initial energy shock could start pulling up prices of other goods and services, eventually spilling into wage push inflation as well. However, economists point out that such second-round price effects and wage pressure have not materialized supporting the stance for a rate hold.

There is still an expectation of a one more rate hike in September or October, since energy prices could remain well above pre-war levels and with uncertainty on the peace-deal between Iran and the US over the Middle East situation. There are also worries on the side of Agricultural supply with the shortage of fertilizer as a result of the Middle East conflict and the European heatwave reducing crop yield that could put upward price pressure on food, lifting inflation despite fall in energy prices.

At the time of writing this piece, the ECB Watch, point to a 96% probability of a rate hold at its current deposit facility rate at 2.25% and a 4% probability of a 25-bps increase to 2.50% for the July 23^rd policy decision signaling the market implied stand on the ECB’s policy decision.

What does all this mean for Sri Lanka?

The fall in global oil prices would have a significant favorable impact on the country’s rising oil bill. With fuel imports bill spiking at USD 630 million in March and USD 866 million in April before reducing to USD 536 million in May, a fall in global oil prices would positive impact Sri Lanka’s current account and a similar negative pressure on Inflation with CCPI rising to a 3-year high in June.

A fall in Europe’s consumer prices would also further reduce domestic inflation as a result of reduction in prices of Sri Lanka’s imports from EU which accounts for about USD 1.15 billion worth of goods annually. A fall in global oil prices would also have easing pressure on the rupee, which has depreciated 7% so far this year, possibly bringing more positive macroeconomic dynamics into the economy since the start of the Middle East conflict earlier this year.