FRANKFURT, Germany (AP) — While the U.S. Federal Reserve has pressed the pause button on interest rate hikes, the European Central Bank remains on a fast track, grappling with inflation that burdens consumers with higher expenses across various sectors such as groceries, utilities, and summer vacations.
According to analysts, it is widely expected that the ECB’s governing council will announce a quarter-percentage point increase when they meet on Thursday, just a day after the Fed halted its consecutive 10 rate hikes, at least temporarily.
In contrast, the Fed opted to maintain its key rate unchanged on Wednesday, as it monitors the impact of significantly higher rates on the U.S. economy.
The burning question for the European Central Bank is: How much longer will its own rapid succession of rate increases persist?
One factor favoring further rate hikes by the ECB is that it commenced its tightening cycle later than the Fed and hasn’t raised rates to the same extent. Since July 2022, the ECB has raised its benchmark deposit rate by 3.75 percentage points, whereas the Fed has implemented a 5 percentage point increase since March 2022.
Increasing interest rates has the effect of combating inflation by making borrowing more expensive for individuals seeking auto loans, mortgages, and credit cards. However, this can also have adverse consequences such as weakening the economy and increasing the risk of a recession.
In Europe, there is a particular concern about these potential repercussions, given that the economy experienced a slight contraction in the last months of 2022 and the first three months of this year. Meeting the criteria of two consecutive quarters of declining output would classify the situation as a recession.
Nevertheless, the European Central Bank remains focused on its objective of addressing inflation, which reached 6.1% in May—significantly surpassing its target of 2%. Analysts anticipate that there will be at least one more rate hike at the ECB’s upcoming meeting in July.
What lies beyond that, however, is the pivotal question that will be posed to Christine Lagarde, the President of the bank, during her press conference following the decision.
In a recent speech, Christine Lagarde highlighted that there is currently no definitive evidence indicating that underlying inflation has reached its peak. Although overall inflation decreased from 7% in April, core inflation—which excludes the volatile prices of food and energy—remains elevated at 5.3% and is declining at a sluggish pace.
While a pause in interest rate hikes might be warranted following the ECB’s decision on Thursday, the gradual descent of inflation implies that the likelihood of another rate increase in July remains significant, according to Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.
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According to Frederik Ducrozet’s research note, he asserts that while core inflation dynamics have shifted, the process of disinflation is expected to be protracted and marked by fluctuations.
The decision made by the Federal Reserve does not eliminate the possibility of further rate hikes. In fact, the Fed’s projections suggest that two more increases could occur within this year. The impact of higher rates on the economy and their intended effect of curbing inflation by increasing the cost of credit for consumer spending and business growth takes time to materialize. It may take several months for the effects to propagate through the economy, ultimately reducing demand for goods and thereby stabilizing prices.
A pause in rate hikes presents an opportunity to assess whether the measures taken are effectively addressing the issue of inflation without causing significant negative impacts on economic growth.
Despite a slight contraction in Europe’s economy, the job market remains robust. Unemployment is currently at its lowest level since the introduction of the euro currency in 1999, standing at 6.5%. Such low unemployment figures are not typically indicative of a genuine recession. However, they do imply the potential for further wage increases, which could exacerbate inflationary pressures as employers vie for scarce workers within the 20 eurozone countries.
The Euro Area Business Cycle Dating Committee, which considers both economic growth and employment data in determining the occurrence of a recession, found no evidence of a recession in its last assessment on March 27. The committee will reevaluate the situation in November.
The decision by central banks in Australia and Canada to resume rate hikes after a period of pause serves as an indication of how widespread and entrenched the issue of inflation has become.
The resurgence of consumer prices can be attributed to the global economy’s recovery from the COVID-19 pandemic, which led to supply chain bottlenecks. Additionally, the spike in oil and natural gas prices was a result of Russia’s threats against Ukraine and its invasion in February 2022. These geopolitical tensions disrupted supplies from major agricultural exporters, leading to soaring prices of food and fertilizer.
Although these pressures are gradually subsiding, the initial surge in inflation has influenced higher wage expectations and increased prices for services. This trend persists, even as energy prices have declined in Europe over the past few months.