Inflation in Europe rose to 2.6% on an annual basis in May, according to official figures on Friday. That’s more than expected as a painful spike in consumer prices takes time to fade.
Still, this is unlikely to hold back development European Central Bank of implementing a first interest rate cut next week – and anticipating the US Federal Reserve in lowering financing costs for businesses and consumers.
The official figure for the twenty countries that use the euro corresponds to 2.4% in April, according to the European Union statistics office Eurostat. The markets had expected 2.5% for May.
The ECB would have an advantage over the US Federal Reserve, which has not lowered interest rates due to more persistent inflation in the US. That would mark a reversal from the rate hike cycle, when the ECB lagged the Fed in raising rates as inflation broke out in the world’s developed economies. US consumer inflation stood at a seasonally unadjusted annual rate of 3.4% in April.
In this case, the ECB faces a different economic situation, as it was hit harder by a spike in energy prices, which has now subsided. US inflation is fueled by higher stimulus spending during and after the coronavirus pandemic and more robust growth, putting the Fed in a different situation.
Inflation rose to double digits in Europe after Russia cut off most natural gas pipelines large-scale invasion of Ukraine, and when the pandemic’s resurgence clogged parts and raw material supply chains. Inflation has fallen as energy prices have fallen and supply problems have 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 persistently higher prices in the services sector, a broad category that includes everything from hotel rooms to medical care to concert tickets, and where wages make up a large part of the cost of doing business. Services prices rose by 4.1% in May, while energy prices rose just shy of 0.3% and food inflation did not exceed the headline rate of 2.6%.
As inflation has fallen towards the ECB’s target of 2%, concerns about growth have become more prominent. The eurozone has not shown a significant increase in gross domestic product over the past four years. While higher interest rates fight inflation by making it more expensive to borrow and buy things, they can also depress growth.
ECB officials have made clear that a rate cut from the current record high of 4% is on the table when the bank’s rate council meets in Frankfurt. Bank president Christine Lagarde said last week she was “really confident” inflation was under control.
Philip Lane, a member of the six-member board that runs the bank day-to-day at its Frankfurt headquarters, was quoted by the Financial Times as saying officials were “prepared to remove the top layer of restrictions” on borrowing costs. Lane is the official who prepares monetary policy decisions for the 26-member board that sets interest rate benchmarks, the other members of which are the heads of the national central banks in the eurozone countries.
It remains unclear how quickly the bank will cut interest rates at subsequent meetings. Recently better growth indicators for Europe, as well as persistent inflation and higher wage growth “could argue against a rate cut next week,” said Carsten Brzeski, global head of macro at ING bank.
“However, the ECB’s own communications over the past two months have made it almost impossible not to make cuts,” Brzeski said. That means the bank can take “very gradual” steps to cut interest rates after the June meeting, while still keeping them at levels that limit lending, growth and inflation.
