The U.S. Federal Reserve may have hit “pause” on interest rate hikes, but the European Central Bank still has its finger on “fast forward” as inflation plagues consumers with higher costs for everything from groceries to utility bills and summer vacations.
Analysts say an increase of a quarter-percentage point is a foregone conclusion when the ECB’s governing council meets Thursday, a day after the Fed took at least a temporary breather after 10 straight hikes.
The Fed made no change in its key rate Wednesday as it waits to see the impact of sharply higher rates on the U.S. economy.
The question for the European Central Bank is: How much longer will its own rapid series of rate increases last?
One reason for the ECB to keep hiking is that it started later than the Fed and has not raised as far, increasing its benchmark deposit rate by 3.75 percentage points since July 2022, while the Fed has laid on 5 percentage points since March 2022.
Higher rates fight inflation by raising the cost of borrowing for auto loans, mortgages and credit cards but also can weaken the economy and raise the risk of throwing the economy into recession.
That is a concern in Europe, where the economy contracted slightly in the last months of 2022 and the first three months of this year. Two straight quarters of falling output is one definition of recession.
Even so, the ECB is keeping its eye on targeting inflation, which came in at 6.1% in May – far above its goal of 2%. Analysts expect at least one more rate hike at the bank’s next meeting in July.
What happens after that, however, is the big question that will be posed to bank President Christine Lagarde at her post-decision news conference.
She noted in a recent speech that “there is no clear evidence that underlying inflation has peaked.” Overall inflation did fall from 7% in April, but core inflation – which excludes volatile food and energy prices – is still high at 5.3% and coming down only slowly.
While a pause in rate hikes could be justified following Thursday’s decision, inflation is coming down only gradually, so “the risk of another rate hike in July remains high,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.
“Core inflation dynamics have turned, but the disinflation process is likely to be unusually slow and bumpy,” he said in a research note.
The Fed decision doesn’t preclude more increases, and in fact its projections indicate two more hikes are possible this year. It takes months for higher rates to work their way through to the economy and achieve the desired effect of cooling off inflation by making credit more expensive for purchases and business expansion, dampening demand for goods that drives up prices.
A pause can be a chance to see if the medicine is working without excessive side effects on economic growth.
While Europe’s economy has shrunk slightly, the job market is strong. Unemployment is the lowest since the euro currency was introduced in 1999 – at 6.5% – and is hardly consistent with a real recession. It also signals more wage increases that could worsen inflation as employers compete for scarce workers in the 20 countries that use the euro.
The Euro Area Business Cycle Dating Committee, which uses employment as well as economic growth data in determining when a recession has occurred, found no recession at its last assessment March 27 and will revisit the question in November.
Central banks in Australia and Canada resumed rate hikes last week after taking a break, one sign of how widespread and ingrained the outbreak of inflation has become.
Consumer prices started rising as the global economy bounced back from the COVID-19 pandemic and created supply chain bottlenecks. Oil and natural gas prices also spiked due to Russia’s threats against Ukraine and after its February 2022 invasion. That also sent food and fertilizer prices soaring amid disruption to supplies from the warring countries, both major agricultural exporters.
Those pressures are starting to ease, but the initial burst of inflation is being reflected in higher wage demands and prices for services, even as energy prices have fallen in Europe in recent months.
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