Eurozone Inflation Drops Below 2%, Boosting Chance of October ECB Cut

"After the spike in inflation we witnessed in July, investors will be glad to see a second straight month of declines, with inflation falling below expectations to 1.8% in September, the lowest reading in more than three years. The continued fall also brings us below the European Central Bank’s 2% targeted level," said Michael Field, European Market Strategist at Morningstar. 

"Core inflation, the measure that strips out volatile components such as fuel and food, also fell by 10 basis points to 2.7%. Granted this number remains materially higher than the 2% targeted inflation level; however, it is at least moving in the right direction," Field added.

"With inflation seemingly settling at or around where we need it to be, and unemployment stable, the ECB should be reaffirmed in its course of action. Expectations were for one more cut before the end of 2024, something that is very achievable given the data."

In September's preliminary inflation figure, the greatest contribution is expected to come from services (4.0%, compared with 4.1% in August), followed by food, alcohol and tobacco (2.4%, compared with 2.3% in August), non-energy industrial goods (0.4%, stable compared to August), and energy (-6.0% compared to -3.0% in August), according to Eurostat. 

Inflation Decline Led by Europe's Largest Economies

Country-level data showed a fall in most of the eurozone economies. Prices in Germany were just 1.6% higher year on year, down from 1.97% in August, according to preliminary data from the country's statistics office Destatis released on Monday. Core inflation, however, is expected at 2.7%, Destatis stated.

"Headline inflation in Germany dropped again in September, giving ECB doves additional reasons to consider reintroducing the rate cut option at the October meeting. It has everything the ECB needs," said Carsten Brzeski, Head of Global Macro at ING, in a note on September 30. "At first glance, the drop in headline inflation is once again the result of favorable energy price base effects. And, indeed, gasoline prices in September were some 15% lower than a year ago, and electricity prices some 25%. At second glance, however, components of some of the regional state inflation data point to a tentative broadening of disinflation," Brzeski added.

In France, September headline inflation rate fell to 1.2% year on year, down from 2.2% in August and 2.7% in July, according to a release by statistic agency Insee on September 27.

In Spain, price rises slowed to 1.5%, compared to 2.2% for August, according to flash data from the local statistics office INE, also on September 27. In Italy, the Consumer Price Index increased by 0.7% on an annual basis (from 1.1% in august), according to ISTAT’s preliminary estimates from September 30.

In the Netherlands, meanwhile, inflation stayed at a relatively elevated 3.5%, according to national statistics bureau CBS on Tuesday, following 3.6% in August and 3.7% in July, mainly fueled by service inflation of 5.6% in September due to rising wages.

Will the ECB Cut Interest Rates in October?

The next ECB meeting will take place on October 17 and the likelihood of a further rate cut has risen sharply in the past week. After digesting inflation data from individual  European countries, "the majority of the market expects a 25 basis points rate cut in October", said Olaf van den Heuvel, CIO of Aegon Asset Management, at an investor event on Monday.

There's "no reason to wait", Deutsche Bank analysts wrote in a note on Tuesday, after German inflation showed "a deeper dip than we were expecting". Following that, the analysts "are accelerating the next ECB 25 basis points rate cut from December to October," adding such a cut would "better balance the risks to the path of inflation going forward but rates will still be restrictive." 

Meanwhile, European Central Bank President Christine Lagarde gave a hint herself on Monday in a hearing in the European Parliament, saying “the latest developments strengthen our confidence that inflation will return to target in a timely manner,” and that ”we will take that into account in our next monetary policy meeting in October”, as reported by Politico.  

Deutsche Bank's analysts also see room for positive revisions to the ECB's inflation forecasts. "The faster recent decline makes it more likely that the ECB revises down its forecasts in December and sees inflation sustainably converge to target earlier than Q4 2025," they wrote. 

The ECB cut its deposit facility interest rate by 25 basis points to 3.50% on September 12, following a cut by 25 basis points on June 6, which had been its first cut in five years.

Could Inflation Soon Be Too Low?

Rapidly declining inflation means that concerns about future growth could soon move into the spotlight, ING Chief Economist Bert Colijn points out: "With inflation moving towards target faster than expected, the European Central Bank’s concerns seem to be shifting towards the lacklustre growth environment."

"Recent survey data has confirmed slowing selling price expectations from businesses. This is mainly because of weak demand as the same surveys indicate that growth is slowing from an already modest pace in the second quarter. Since the summer, concerns about inflation have made way for concerns about economic growth," he adds.

Colijn raises the scenario of inflation possibly going too low: "As the ECB seems quite convinced that inflation is on track towards 2%, the question is now how fast it wants to move interest rates back to neutral. If it keeps interest rates restrictive for too long with the economy already slowing, it risks pushing inflation below its 2% target. With growth under pressure now, it seems that the door is open for the ECB to move faster. While it does not seem like a done deal, it does bring the October meeting into play for a possible step up in easing."