Inflation in Europe rose to 2.6% year on year in May, official data showed on Friday. That’s more than expected given the painful surge in consumer prices. it takes time to disappear.
However, this is unlikely to stop European Central Bank from the first interest rate cut next week – and ahead US Federal Reserve in reducing borrowing costs for businesses and consumers.
The official rate for the 20 countries using the euro was 2.4% in April, according to the European Union’s statistics agency Eurostat. Markets had expected a 2.5% rise in May.
The ECB will find itself facing a US Federal Reserve that is holding back on rate cuts due to more persistent US inflation. This would mark a shift from the rate-hiking cycle, in which the ECB lagged behind the Fed in raising rates as inflation flared across the world’s advanced economies. US consumer inflation in April was 3.4% annualized, not seasonally adjusted.
In this case, the ECB faces a different economic situation, as it was hit harder by the surge in energy prices, which has now subsided. US inflation has been fueled by higher stimulus spending during and after the coronavirus pandemic, as well as more resilient growth, putting the Fed in a different situation.
Inflation in Europe rose to double digits after Russia cut off most of its natural gas pipeline supplies. full-scale invasion of Ukraine, and as the recovery from the pandemic began, supply chains for parts and raw materials became clogged. Inflation fell as energy prices fell and supply disruptions eased.
The decline in inflation has slowed in recent months as workers have pushed for higher wage deals to compensate for lost purchasing power. That has led to sustained price increases in the service sector, a broad category that includes everything from hotel rooms to medical care to concert tickets, where wages make up the bulk of the cost of doing business. Prices for services rose 4.1% in May, although energy prices rose just 0.3% and food inflation stayed below the headline rate of 2.6%.
As inflation has fallen to the ECB’s 2% target, concerns about economic growth have become more prominent. The eurozone has not shown significant growth in gross domestic product in four years. While higher rates combat inflation by making borrowing and shopping more expensive, they can also curb economic growth.
ECB officials have made it clear that a rate cut from the current record high of 4% will be discussed at the bank’s rate board meeting in Frankfurt. Bank President Christine Lagarde said last week that it was “really confident” that inflation was under control.
Philip Lane, a member of the six-member executive board that runs the bank on a day-to-day basis from its Frankfurt headquarters, was quoted by the Financial Times as saying officials were “ready to lift the cap on borrowing costs.” Lane is the official who prepares monetary policy decisions for the 26-member governing council that sets benchmark rates, the other members of which are the heads of national central banks in eurozone countries.
How quickly the bank will cut rates at subsequent meetings remains open. Recent improvement in economic growth in Europe, as well as persistent inflation and higher wage growth, “could argue against a rate cut next week,” said Carsten Brzeski, head of global macroeconomics at ING bank.
“However, the ECB’s own messages over the past two months have made it virtually impossible not to cut spending,” Brzeski said. That means the bank could move to cut rates “very gradually” after its June meeting while keeping them at levels that cap lending, economic growth and inflation.