Inflation in Europe edges down again. But will Houthi attacks on ships spoil the relief?

FRANKFURT, Germany (AP) — Inflation in Europe edged lower in January to 2.8%, keeping alive speculation about quicker interest rate cuts that would lower borrowing costs for businesses and consumers — and help boost the stagnating economy.

The annual figure released Thursday by the European Union statistics agency Eurostat was down from 2.9% in December and matched what market analysts expected.

Energy prices fell 6.3%, contributing to the drop in inflation in the 20 European Union countries that use the euro currency. The overall decline brings the European Central Bank closer to its goal of 2% considered best for the economy.

Inflation has fallen steadily as the ECB rapidly raised interest rates, the typical antidote to out-of-control price increases.

It should help the lagging European economy grow later this year as moderating prices and wage increases help consumers make up the purchasing power they lost when inflation surged to record-high double digits in late 2022.

Inflation decreased to 3.1% in Germany, Europe’s biggest economy, down from 3.8% in December and the lowest since June 2021. France, Europe’s No. 2 economy and among those facing protests from farmers angry about higher costs and lower pay, saw inflation dip to 3.4% in January from 4.1% a month earlier.

Core inflation, which excludes volatile food and energy prices and is monitored closely by the ECB, fell to 3.3% from 3.4%.

Yet the downward inflation path faces risks from disruptions to shipping through the Red Sea, a key route for goods and fuel headed for Europe.

Attacks on ships by Iranian-backed Houthi rebels in Yemen have led to ships being routed around the southern tip of Africa rather than taking the shorter route through the Suez Canal. That has raised shipping costs and could slow the decline in inflation.

The trade disruption has so far not led to a spike in prices for oil and natural gas, but that remains a risk if the Israel-Hamas war escalates or spreads to other countries in the Middle East.

“While we expect the impact on CPI inflation to be small, it will take time before this becomes unambiguously clear,” said Ben May, director of global macro research at Oxford Economics. “This uncertainty could ultimately prompt central banks to delay rate cuts to give themselves more information on the inflationary impact."

Economic models suggested the impact could be as small as 0.3% on inflation, May said.

The decline in inflation has unleashed speculation that the European Central Bank could start cutting interest rates as early as April.

ECB officials — much like policymakers at the Bank of England who met Thursday and the U.S. Federal Reserve a day earlier — have not committed to a timetable for rate cuts, saying they will decide based on incoming economic data to ensure inflation is definitely trending toward their target.

Some analysts say a cut is more likely at the bank's June policy meeting, around the same time the Fed is expected to cut. The ECB’s benchmark rate is at a record-high 4% after being hiked from negative levels in just over a year.

Higher rates combat inflation by making people's purchases on credit more expensive, thus holding back spending. For the same reason, they can weigh down economic growth, particularly in credit-sensitive sectors such as construction and home sales.

And European growth could use a boost. The economy recorded zero growth in the last three months of 2023 and has shown no significant increase in output since the third quarter of 2022, although unemployment remains low.

The tepid performance contrasts with stronger-than-expected growth in the U.S. of 0.8% in the fourth quarter, or an annual pace of 3.3%.