UPDATE 1-Euro zone inflation rises in fresh signal for ECB caution

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<slugline separator="-">EUROZONE-ECONOMY/INFLATION (UPDATE 1, PIX)</slugline>
<headline>UPDATE 1-Euro zone inflation rises in fresh signal for ECB caution</headline>
<dateline>FRANKFURT, May 31 (Reuters)</dateline>
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<by>By Francesco Canepa</by>
<description role="descRole:caption">EUROZONE-ECONOMY/INFLATION (UPDATE 1, PIX):UPDATE 1-Euro zone inflation rises in fresh signal for ECB caution</description>
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<p>*</p>
<p>Headline and core inflation rise more than expected</p>
<p/>
<p>*</p>
<p>Services inflation rebounds</p>
<p/>
<p>*</p>
<p>Panetta insists data neither good nor bad</p>
<p>(Adds reactions in paragraphs 3, 6 and 12)</p>
<p>By Francesco Canepa</p>
<p>FRANKFURT, May 31 (Reuters) - Euro zone inflation rose
in May, data showed on Friday, in a sign the European Central
Bank still faces a slow and uncertain journey to reach its goal
of fully reining in prices.</p>
<p>The bigger-than-expected increase in inflation was unlikely
to stop the ECB from lowering borrowing costs from a record high
next week, but may cement the case for a pause in July and a
slower pace of interest rate reductions in the coming months.</p>
<p>"These numbers strengthen the hands of those who say we need
to be cautious," Dirk Schumacher, an economist at Natixis, said.</p>
<p>Consumer prices in the 20 countries that share the euro rose
by 2.6% year on year in May, inching away from the ECB's 2%
target after increases of 2.4% in the previous two months,
according to Eurostat's flash estimate.</p>
<p>Economists polled by Reuters had anticipated inflation would
rise to 2.5%, fuelled in part by an unfavourable comparison to
last year when Germany had subsidised rail travel, among other
one-off factors.</p>
<p>ECB policymaker Fabio Panetta, the governor of the Bank
of Italy, said the latest reading was neither good nor bad as he
reaffirmed his view that the central bank could cut rates
several times and still keep the brakes on the economy.</p>
<p>More significantly, a closely watched measure of underlying
inflation that excludes food, energy, alcohol and tobacco came
in at 2.9% from 2.7% in April.</p>
<p>Prices in the services sector, which some policymakers have
singled out as especially relevant because they reflect domestic
demand, rebounded to 4.1% from 3.7%.</p>
<p>This was likely to mirror larger-than-expected increases in
wages in the first quarter of the year, which have boosted
consumers' battered disposable income after years of
below-inflation pay hikes.</p>
<p>The ECB's biggest ever streak of rate hikes has helped bring
down inflation, which reached from 10% in late 2022 due to the
surge in energy prices in the wake of Russia's invasion of
Ukraine. The hikes have stabilised consumer inflation
expectations but also choked off credit.</p>
<p>This meant that policymakers meeting next week were likely
to stick to well-telegraphed plans to cut rates despite growing
market doubts about a global narrative of falling inflation.</p>
<p>"We think that the latest inflation and wage figures
decrease the likelihood of back-to-back interest rate cuts in
July, but we see the ECB cutting rates twice more before the end
of the year if the downward trend in inflation resumes during
the third quarter as expected," said Diego Iscaro, head of
European economics at S&amp;P Global Market Intelligence.</p>
<p>German government bond yields - the benchmark for euro
zone borrowing costs - reached their</p>
<p>highest in over six months</p>
<p>after inflation data was released.</p>
<p>Markets are currently pricing around 57 basis points of
ECB rate cuts in 2024, and are indicating a 25 basis point cut
in June, and one more by year end. In recent weeks, however,
they have been gradually paring back expectations of a third cut
this year.
(Reporting By Francesco Canepa; Editing by Toby Chopra)</p>
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