May 3, 2018 / 9:06 AM / 5 months ago

Euro zone inflation slowdown adds to ECB's headache

BRUSSELS/FRANKFURT (Reuters) - Euro zone inflation unexpectedly slowed last month, adding to a string of data that points to a cooling economy and possibly makes it more difficult for the European Central Bank to curb its lavish monetary stimulus later this year.

Last month the rate slipped to an annual 1.2 percent, missing economists’ expectations in a Reuters poll that it would remain at the March level of 1.3 percent.

The weak reading follows disappointing GDP, output, export and sentiment figures, which suggest that euro zone economic growth has peaked after a five-year run and will at best slow to a more moderate level, below optimistic forecasts at the start of the year.

This comes at a sensitive time for the ECB as policymakers are debating whether to end a 2.55 trillion euro ($3.1 trillion) bond buying scheme this year, satisfied that healthy growth will eventually raise inflation back to its target of almost 2 percent.

Introduced more than three years ago to boost flagging growth and inflation, the ECB’s bond purchases helped to revive the economy with a flood of cheap cash. The program is due to run out at the end of September and policymakers need to decide over the summer whether to shut it down after several extensions.

But inflation has failed to rise for years according to expectations and in April it also missed the ECB’s prediction of a rate “around” 1.5 percent for the rest of the year.

Perhaps more worryingly for the ECB, all measures of closely-watched underlying inflation fell, indicating that pressures remain weak, despite robust employment growth and a healthy wage deal in Germany, the bloc’s biggest economy.

Inflation excluding volatile food and energy prices, the ECB’s preferred measure, slowed to 1.1 percent from 1.3 percent. The rate excluding energy, food, alcohol and tobacco, an even more narrow measure often looked at by market analysts, eased to 0.7 percent from 1 percent.

ECB chief economist Peter Praet said the slowdown had come sooner than expected and factors holding back growth may persist in the near term, but he played down the data.

“We cannot yet declare ‘mission accomplished’ on the inflation front, but we have made substantial progress on the path towards a sustained adjustment in inflation,” he said in Paris.

TOO EARLY TO PANIC

Economists said it was too early for the ECB to panic as one-off factors such as the effects of the Easter holidays - which in 2018 fell right at the start of the month compared with mid-April in 2017 - on the year-on-year comparison. Higher oil prices could still boost inflation in the coming months.

“The April decline in inflation owes largely to the timing of Easter and should correct itself next month,” Berenberg economist,” Berenberg economic Florian Hense said.

FILE PHOTO: A waitress places food on display at a ham shop in downtown Ronda, near Malaga, Spain September 4, 2017. REUTERS/Jon Nazca/File Photo

“The ECB will look through the volatility in the current inflation data,” he said. “An oil-driven spike in headline inflation up to 1.7 percent or even 1.8 percent in the summer months may possibly scare some observers.”

The euro extended its recent slide on the data and bond yields fell as investors are pricing in even slower policy normalization by the ECB. While the currency is broadly unchanged this year, it is down 3 percent in the past three months as investors give up expectations that the ECB will tighten policy more aggressively.

Inflation has slowed even though crude oil prices LCOc1 are up around 40 percent from a year earlier, suggesting that the rate would be even weaker with steady energy costs.

“Today’s data increase the likelihood that the ECB will have to lower not only its growth but also core inflation projection in June,” Commerzbank economist Christoph Weil said. “Nevertheless, it will still probably discontinue its bond purchase program at the end of the year.”

While policymakers have played down the impact of the weak growth so far, they are expected to delay their final decision until the last possible moment, assessing whether growth would stabilize or slow further.

The bloc’s GDP growth slowed to 0.4 percent in the first quarter from 0.7 percent three months earlier and the European Commission said downside risks to growth have increased.

($1 = 0.8331 euros)

People sit inside a coffee shop of a luxury goods department store at the Friedrichstrasse street in Berlin, May 21 2012. REUTERS/Fabrizio Bensch/File Photo

Reporting by Philip Blenkinsop; editing by Robert-Jan Bartunek and David Stamp

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