Eurozone inflation falls reflecting a dichotomy at the heart of the European economy

Eurozone inflation fell to 2.8% in June, reflecting a dichotomy at the heart of the European economy. On the one hand, the conflict in the Middle East has led to energy supply disruptions and periods of higher crude oil prices, increasing fuel, transport and production costs that eventually feed into consumer prices.

But on the other hand, economic activity remains weak. With businesses cautious about investment and consumer demand subdued, overall spending in the economy remains low.

Added to this, wage growth has hovered around 3% over the past year and energy markets are showing signs of stabilising. The recent ceasefire agreed between the US and Iran has opened up the prospect of a lasting reduction in regional tensions, reducing the risk of renewed upheavals to global oil and gas supplies. If maintained, lower energy costs will gradually feed through to transport, manufacturing, and distribution sectors in the coming months, easing cost pressures for businesses.

Rising inflation prompted the European Central Bank to raise interest rates in June, but policymakers know that there is no need to panic. We may see one further hike this year – taking interest rates up to 2.5% – but we are unlikely to see more drastic action taken. With the economy weak and inflation appearing manageable, the ECB will be wary of adopting a significantly more restrictive monetary policy stance.