ECB’s 2% landing masks a big spectrum of euro-zone inflation

For European Central Bank officials marking the achievement of price stability within the euro zone, there’s a caveat: inflation at 2% is all a bit relative.

While that target number is what the most recent reading for the overall euro zone shows, only one Governing Council member leaving Frankfurt after the last gathering that ended on 24 July went home to an economy exactly at the goal: Finland’s Olli Rehn.

Among 19 other members, some are seeing next-to-no growth in consumer prices, while others have levels of more than two, or nearly three times the 2% level.

Divergence among euro-zone economies on key metrics — inflation included — is part of the challenge officials have always grappled with in steering policy in a huge region of more than 350 million people. But at a time of fragile growth and heightened trade tensions, it complicates an already difficult job.

The Governing Council kept interest rates unchanged in July following eight reductions in a year, and President Christine Lagarde said the ECB is in a “good place because inflation is at 2%” and “our projections point to inflation stabilizing at target in the medium term.”

While she refused to be drawn on whether officials would resume cutting the deposit rate — currently at 2% — in September or hold firm, traders pared bets on another step this year.

Reading the data

One more inflation report is due before the ECB’s next decision, and updated projections available at the September meeting will be another important input for officials.

July data showed that the gap between the lowest and highest readings for price growth in the euro zone have continued to widen from a recent low at the start of the year.

At 5.5 percentage points, it compares to a peak of 18.6 percentage points shortly after the ECB started raising rates to combat surging prices. The gap averaged 3.6 percentage points from the creation of the euro to the month Russia invaded Ukraine, setting off a once-in-a-generation price shock.

Among those undershooting the euro area’s 2% rate in July were its three biggest members — Germany, France and Italy — along with Ireland and Cyprus. The remaining 14 reported higher figures.

The Governing Council takes its decisions based on what’s best for the euro zone, but that doesn’t force policymakers to turn a blind eye to their home economies. There’s even a notable coincidence between some of their recent views and whether local consumer-price growth is above or below target.

Greece’s Yannis Stournaras, who has tended to lean dovish, has argued as far back as June that the ECB had reached an equilibrium when it comes to inflation, banking-sector developments and economic growth, and signaled a reluctance to cut rates further. Greek inflation was 3.7% in July.

His colleague Jose Luis Escriva from Spain urged “patience” to avoid rushing into decisions that might turn out to be wrong, also seemingly in favor of keeping borrowing costs on hold. The most recent price-growth reading there was 2.7%.

Meanwhile Bank of France Governor Francois Villeroy de Galhau has pressed that it’s “important to remain completely open” about future decisions. French inflation has been below 2% for almost a year, and was most recently 0.9%.

Italy’s Fabio Panetta, who observed price pressures of 1.7% at home last month, said “it would be appropriate to continue with monetary easing” if weaker growth were to weigh more heavily on inflation.

Whatever the ECB’s rate decision in September, its conundrum of inflation diverging across the region won’t go away.

June’s staff projections show consumer-price growth averaging 2% across the euro zone in 2027, underpinning Lagarde’s confidence “that the inflationary shock of the past few years is now behind us.” They also show that only three countries are expected to achieve the same result.

But risks also linger in the composition of inflation beyond geography.

Services prices have risen at a faster pace than the headline rate for more than two years, proving sticky due to wage growth that only recently peaked.

While services have exceeded regular consumer-price gains more often than not since the euro’s introduction in 1999, the current overshoot of 1.1 percentage points is bigger than the average one.

That may be one reason why Lagarde has been adamant in saying that the ECB’s mission isn’t yet accomplished, even if the 2% inflation target is reached.

Price growth could turn out to be lower than predicted due to a stronger euro, cheap products arriving in the euro zone from countries facing high US tariffs, weaker demand for the region’s exports and uncertainty keeping consumers at home, she said following the latest decision.

Upside risks include capacity constraints on the back of supply-chain disruptions, higher infrastructure and defense spending, and more expensive food due to extreme weather events.

“The outlook for inflation is more uncertain than usual,” Lagarde explained. “Our job now is to look at what’s coming and to try to, first of all, wait because there are a lot of elements that will pan out in the next few months and see what impact it will have on our economy.”