(Adds market reaction, analyst)By Jan Strupczewski and Balazs KoranyiBRUSSELS/FRANKFURT, June 4 (Reuters) - Euro zone inflationfell more than expected last month, adding to worries about weakprice pressure and reinforcing the case for more stimulus by theEuropean Central Bank.
With growth slowing as a global trade war heats up, majorcentral banks appear to have given up plans to tighten policyand investors now expect them to provide even more stimulus.
Inflation in the 19 countries sharing the euro fell to 1.2%in May from 1.7% in April, below expectations of 1.3% and morethan reversing a one-off surge related to the timing of Easter.In a more worrisome sign, the ECB's preferred measure,underlying inflation -- excluding volatile food and energyprices -- fell to 1.0% from 1.4% a month earlier, indicatingthat a long-projected pick-up has still not begun.
With the data suggesting more ECB support may be coming,bond yields dropped further on Tuesday, moving towards record ormulti-year lows.
The 10-year Germany bond fell to minus 0.21% ,within sight of Monday's record low. The 30-year French bondfell about four basis points to 1.19% , its lowestsince late 2016.Bank shares rose, partly on expectations the ECBwould need to give the euro zone economy a boost and providebanks with cheap funding.The ECB targets inflation at just below 2%, but it hasundershot that since 2013, raising fears that such a persistentmiss could permanently lower inflation expectations, making weakprice growth self-perpetuating.Minutes of the ECB's last meeting showed growing concernabout weakening inflation expectations, which raises pressure onpolicymakers to provide further stimulus.
But the bank has already exhausted much of its firepower.Although it has plenty of tools left, they lack the potency ofearlier measures, such as massive asset purchases or rapid ratecuts.The ECB's next move, expected at Thursday's meeting, will beto provide banks with new longer-term refinancing operations orTLTROs, -- loans at super low, probably negative interest rates."Today's drop in core inflation ... will only add to thecase for a dovish outcome while our measures of inflationexpectations continue to drift lower," Pictet Wealth Managementstrategist Frederik Ducrozet said. "We expect TLTRO to be pricedat a negative rate of -0.20%, or lower."Lending data suggests the availability of funding is not anissue for now, but the weak inflation reading and slowing growthare likely to persuade policymakers to price the loans undergenerous terms.But the ECB may hold off on other easing measures for now.Growth is holding up, wages are rising, credit growth remainsrobust and unemployment reached a 10-year-low of 7.6% in April.
Still, more support may be needed before summer is over. Atrade war is sapping confidence, Italy is again quarreling withthe European Commission, German industry continues to postdismal figures, stocks are tumbling and the threat of a hardBrexit looms.Markets have already pushed out expectations for a rateincrease into 2021 and some are even pricing in a rate cut. Thatmove is still unlikely, since the ECB's key rate is already at arecord low of minus 0.4%To maintain credibility, the ECB's next move then may be toadjust its forward guidance and formally delay any rateincrease. It now foresees steady rates until next year. (Editing by Philip Blenkinsop, Jon Boyle, Larry King)
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