FILE PHOTO: A shopper pays with a five Euro bank note to buy eggs at a local market in Nice, France, April 26, 2023. REUTERS/Eric Gaillard/File Photo
FILE PHOTO: A shopper pays with a ten Euro bank note at a local market in Aix-en-Provence, France, January 16, 2025. REUTERS/Manon Cruz/File Photo
FILE PHOTO: A shopping trolley is filled with food products at Caritas Emporium, in Rome, Italy, February 27, 2024. REUTERS/Guglielmo Mangiapane/File Photo

By Balazs Koranyi

FRANKFURT (Reuters) -Euro zone inflation edged up a touch in August, staying close to the ECB's 2% target and likely firming up market bets that interest rates will remain unchanged in the near term, even if the rate cut debate could still simmer.

Price growth, the European Central Bank's primary focus, has slowed sharply in recent years and has been on target for months, a rare success for the bank which undershot its mark for a decade before the pandemic, only to struggle with runaway prices in subsequent years.

Inflation in the 20 nations sharing the euro picked up to 2.1% last month from 2.0% in July, just above expectations for 2.0% in a Reuters poll, on a rise in unprocessed food prices and a smaller drag from lower energy costs, data from Eurostat showed on Tuesday.

A more closely watched figure on underlying prices, which exclude volatile food and fuels prices, meanwhile held steady at 2.3%, above expectations for a fall to 2.2%, even as crucial services inflation continued to slow to 3.1% from 3.2%.

"The descent in services will continue, helped by cooling wage growth," Riccardo Marcelli Fabiani at Oxford Economics said. "Favourable prices in international markets and a stronger euro will keep energy inflation negative and lower imported costs."

The figures confirm the ECB's own projection for inflation to oscillate around target through the end of the year, as muted goods inflation and moderating energy prices offset still robust growth in the price of food and services.

This relative calm in price growth is why markets expect steady interest rates in the coming months, even if policymakers are still likely to debate whether more easing may be needed on top of the two percentage points of rate cuts made since mid-2024.

Such a debate could pick up pace in early 2026 as price growth is expected to undershoot the 2% target, albeit temporarily, raising worries that too low inflation could get entrenched, much like it did in the pre-pandemic years.

For now, markets see just a one-in-four chance of a rate cut by December but pricing goes above 50% by early spring, suggesting that a debate on more easing is far from over.

Anticipating this, ECB board member Isabel Schnabel argued on Tuesday that risks to inflation were actually skewed towards higher readings and she saw no risk of price growth getting stuck under target since economic growth was healthy and trade turmoil would exert upward pressure on costs.

"It is important to acknowledge that we cannot fine-tune inflation in a way that it is always at 2% in a shock-prone world," Schnabel told Reuters. "We can tolerate moderate deviations of inflation from target in either direction."

Other policymakers are less confident in the outlook and continue to openly discuss the possibility of more easing further out.

The ECB will next meet on September 11 and economists overwhelmingly anticipate no change in the 2% deposit rate.

Expectations, however, diverge further out and some still anticipate an 'insurance' cut either at the end of the year or early 2026 to signal that persistent undershooting of inflation will not be tolerated.

"With slow growth, significant risks of downside surprises still prevalent, and the Federal Reserve expected to resume cutting rates again, the doves on the governing council could still push for one more cut before holding steady," ING economist Bert Colijn said.

"Succeeding at that would be a tall order, as the case for holding steady is now quite solid."

(Reporting by Balazs Koranyi; Editing by Toby Chopra)