Euro Zone Inflation Drops to 2-Year Low as Economy Shrinks

Euro Zone Inflation Drops to 2-Year Low as Economy Shrinks

Key Insights

  • Euro zone inflation dropped to a 2-year low of 2.9% in October, easing from 4.3% the previous month and below forecasts.
  • The economy shrank 0.1% in Q3 based on flash estimates, signaling potential technical recession across the bloc.
  • Declining inflation is a positive sign but weak growth underscores risks of ECB overtightening as it continues hiking rates to combat price pressures.

Inflation across the euro zone fell to its lowest level in two years in October, easing to 2.9% from 4.3% the previous month according to preliminary data released on Tuesday.

The drop was below economist forecasts of 3.1% and marks a welcome sign that price pressures may be starting to abate. Core inflation, excluding food and energy, also declined to 4.2% annually.

The data comes amid a cloudier economic picture, with the euro zone logging a 0.1% GDP contraction in the third quarter based on flash estimates. The decline signifies two consecutive quarters of shrinking output that could signal a technical recession.

While the inflation cooldown will be welcomed by the European Central Bank (ECB), the weak growth underscores risks of monetary policy overtightening. The ECB enacted 10 straight interest rate hikes to combat inflation but opted to pause last week.

Looking at components, food and energy prices dropped substantially but remain elevated, said ECB President Christine Lagarde. We will stay vigilant as risks remain tilted to the upside.

Economic performance diverged within the bloc, with Germany eking out a 0.1% GDP decline versus steeper drops in Austria and Ireland. The euro zone is only expected to grow 0.7% this year and 1% in 2024 according to ECB projections.

After hitting a peak of 10.6% in October 2022, the post-pandemic inflation wave appears to be receding for now. But with the ECB signalling rates will remain restrictive for an extended time, the path to recovery could face hurdles.

β€œThe outlook is far from robust, but any sign of inflation moderating will be welcomed,” said economist Erik Jones. For policymakers, finding the right balance remains a precarious challenge.

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