Falling German and French inflation feeds hopes of halt to ECB interest rate rises

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German and French inflation slowed this month to the lowest annual rates since Russia’s full-scale invasion of Ukraine, prompting investors to pare back their bets of another interest rate rise from the European Central Bank.

A slowdown in the cost of most goods and services in Germany helped inflation fall to 6.5 per cent, its lowest level since February 2022 and slightly below forecasts of economists polled by Reuters.

Lower energy costs in France lay behind a drop in inflation to 5 per cent in July. Slowing inflation in Europe’s two largest economies bolstered expectations of a decline in the eurozone number, which is due out on Monday.

In a further positive sign, the French economy rebounded in the three months to June, growing at a faster than expected 0.5 per cent from the previous quarter, although this was largely down to a big cruise ship order. 

Germany’s economy stagnated in the second quarter, ending two consecutive quarters of contractions in output. But this was below the 0.1 per cent growth forecast by economists in a Reuters poll. Robert Habeck, German economy minister, said the latest figures were “far from satisfactory”.

Germany’s rate-sensitive two-year bond yield dipped on Friday as markets pared back their bets on another rate increase from the ECB in September.

However, inflation in Spain accelerated, rising more than expected to 2.1 per cent, up from 1.6 per cent in the previous quarter.

Policymakers at the ECB will be watching Friday’s data closely after leaving the door open to a pause in a year-long period of interest rate rises in September, following a quarter-percentage point increase on Thursday.

While eurozone headline inflation is expected to keep falling, the ECB is concerned about tight job markets and rising wages, particularly in the labour-intensive services sector. Its decision on whether to raise rates again at its next meeting in September could hinge on whether consumer price growth keeps slowing over the next two months.

“The drivers of inflation are changing,” ECB president Christine Lagarde said on Thursday. “External sources of inflation are easing. By contrast, domestic price pressures, including from rising wages and still robust profit margins, are becoming an increasingly important driver of inflation.”

Core inflation, which excludes more volatile energy and food prices to give a better indication of underlying price pressures, fell in Germany to 5.5 per cent, down from 5.8 per cent the previous month.

Carsten Brzeski, an economist at Dutch bank ING, forecast German inflation would fall to 3 per cent by the end of this year. “There is a high chance that we are witnessing the last leg of services inflation, mainly in tourism,” he said.

Energy prices in France fell 3.8 per cent in the year to July. Coupled with a slowdown in food inflation and in manufactured goods inflation, this helped to offset a slight increase in services inflation. Compared with the previous month, French consumer prices were flat, but they rose 0.5 per cent in Germany.

The acceleration of French quarterly growth, up from 0.2 per cent in the first quarter, was above economists’ expectations and signalled GDP figures for the eurozone, which are also due out on Monday, could be stronger than expected.

Insee, the French statistics agency, said business investment was up 0.7 per cent in the second quarter while household spending was down 0.4 per cent. There was a boost from the country’s balance of trade growth as exports rose 2.6 per cent and imports were up only 0.4 per cent.

However, economists said the downturn in French domestic demand could still point to weakness in the wider eurozone economy. French goods consumption fell 0.7 per cent in the second quarter, despite a rebound in May and June, Insee said. 

Claus Vistesen, an economist at consultants Pantheon Macroeconomics, said the “main impetus” to French growth was the “delivery of a cruise ship”, which boosted exports of transport equipment.

Spain’s economy grew 0.4 per cent in the three months to June from the previous quarter, a slowdown from its 0.5 per cent expansion earlier in the year that matched economists’ expectations. 

The country, which is gripped by political deadlock after an inconclusive election left both main parties struggling to form a government, was boosted by a rebound in domestic demand, which expanded 1.9 per cent, offsetting a negative contribution from trade after exports fell 4.1 per cent.

Additional reporting by Guy Chazan in Berlin

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