Inflation divergence masks superficial stability, increasing internal differences complicate the European Central Bank's interest rate decision-making

According to the Zhitong Finance APP, for European Central Bank officials celebrating price stability in the Eurozone, one noteworthy point is that a 2% inflation rate is merely a relative concept. Although the Eurozone's inflation rate remained at the target level of 2% in July, only Finland's inflation rate precisely met this target. In the other 19 Eurozone countries, some saw little increase in inflation, while others had inflation rates exceeding 2%, nearly three times the 2% target level. Data shows that the inflation rates of the Eurozone's three largest economies—Germany, France, and Italy—as well as Ireland and Cyprus, were all below 2% in July, while the inflation rates of the remaining 14 countries were above 2%.

The inflation data for July indicates that the gap between inflation rates among Eurozone countries has continued to widen since the low point at the beginning of the year, with the current difference at 5.5 percentage points. Although this is far below the peak of 18.6 percentage points reached when the European Central Bank initiated interest rate hikes to combat soaring inflation, it is higher than the average gap of 3.6 percentage points from the birth of the euro until the outbreak of the Russia-Ukraine conflict in 2022.

In the economic management of the Eurozone, the differences among member states in key indicators (including inflation) have always posed a challenge for officials. Today, this challenge is further complicated by weak economic growth and escalating trade tensions.

After eight consecutive interest rate cuts over the past year, the European Central Bank decided in July to maintain interest rates. ECB President Christine Lagarde stated that the ECB is "in a good position because the inflation rate has reached 2%" and noted that "our forecasts indicate that inflation will stabilize at the target level in the medium term." Although she declined to disclose whether ECB officials would continue to lower the current deposit facility rate of 2% in September or maintain it, market traders have lowered their expectations for another rate cut by the ECB this year.

While the decisions of the ECB Governing Council are based on considerations most beneficial to the overall interests of the Eurozone, this does not mean that policymakers will ignore their domestic economies. In fact, there is a significant correlation between the policy positions of some council members and whether their domestic inflation is above or below the target.

For example, the Governor of the Bank of Greece, Yannis Stournaras, stated as early as June that the ECB had achieved a balance between inflation, banking sector development, and economic growth, implying a reluctance to further cut rates. Greece's inflation rate in July was 3.7%. The Governor of the Bank of Spain, Jose Luis Escriva, called for "patience" to avoid hasty decisions that could lead to mistakes. He also seems inclined to maintain the current borrowing costs. Spain's inflation rate in July was 2.7%.

In contrast, the Governor of the Bank of France, Francois Villeroy de Galhau, emphasized the importance of "keeping completely open for future decisions." France's inflation rate has been below 2% for nearly a year, with a July inflation rate of only 0.9%. The Governor of the Bank of Italy, Fabio Panetta, pointed out that "if weak growth has a greater impact on inflation, then continuing monetary easing is appropriate." Italy's inflation rate in July was 1.7%.

Regardless of what interest rate decision the European Central Bank makes in September, the issue of inflation divergence within the Eurozone will not disappear. June's forecast indicates that the average inflation rate in the Eurozone will reach 2% by 2027, which supports Lagarde's confidence that "the inflation shocks of the past few years are over." However, the forecast also shows that only three Eurozone countries—Italy, Luxembourg, and Malta—are expected to truly reach the 2% target.

In addition to regional factors, other risks in the inflation structure still exist. The increase in service inflation has exceeded the overall inflation rate for two consecutive years, primarily driven by wage growth that has only recently peaked. Since the euro's inception in 1999, service prices have mostly risen faster than overall consumer price growth, but the current situation, which is 1.1 percentage points higher, has surpassed the average level.

This may be one of the reasons why Lagarde insists that the European Central Bank's mission is not yet complete, even though the overall inflation rate in the Eurozone has reached 2%. Given factors such as the strengthening euro, the influx of cheap goods from countries facing high U.S. tariffs, weakened export demand for the Eurozone, and external uncertainties, future price growth may be lower than expected