Inflation rose in Europe in May but its central bank is still set to cut interest rates before the Fed
Inflation ticked up to an annual 2.6% in Europe in May, according to official figures on Friday. That’s more than expected as a painful spike in consumer prices takes its time to fade away.
Yet that’s unlikely to stop the European Central Bank from making a first interest rate cut next week — and moving ahead of the U.S. Federal Reserve in lowering borrowing costs for businesses and consumers.
The official figure for the 20 countries that use the euro currency compares to 2.4% in April, according to European Union statistics agency Eurostat. Markets had expected 2.5% for May.
The ECB would be out in front of the U.S. Federal Reserve, which has held off on cutting rates because of more persistent inflation in the US. That would be a switch from the hiking cycle, when the ECB lagged the Fed in raising rates as inflation broke out across the world’s developed economies. U.S. consumer inflation ran at a seasonally unadjusted annual rate of 3.4% in April.
In this case, the ECB is facing a different economic situation, since it was hit harder by an energy price spike, which has now faded. Inflation in the U.S. has been fed by higher stimulus spending during and after the coronavirus pandemic and by more robust growth, putting the Fed in a different situation.
Inflation spiked into double digits in Europe after Russia cut off most pipeline supplies of natural gas over its full-scale invasion of Ukraine, and as the rebound from the pandemic clogged supply chains of parts and raw materials. Inflation has fallen, as energy prices have come down and as supply logjams have eased.
The decline in inflation has slowed in recent months as workers have pressed for higher wage agreements to make up for lost purchasing power. That has led to stubbornly higher prices in the services sector, a broad category including everything from hotel rooms to medical care to concert tickets, and where wages make up much of the cost of doing business. Services prices rose 4.1% in May, even as energy prices rose only a bare 0.3% and food inflation ran no more than the overall figure at 2.6%
As inflation has faded toward the ECB’s goal of 2%, concerns about growth have become more prominent. The eurozone has shown no significant increase in gross domestic product in four years. While higher rates combat inflation by making it more expensive to borrow and buy things, they can also weigh on 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-governing council meets in Frankfurt. Bank President Christine Lagarde said last week that she was “really confident” inflation was under control.
Philip Lane, a member of the six-person executive board that runs the bank day to day at its Frankfurt headquarters, was quoted by the Financial Times as saying officials were “ready to remove the top layer of restriction” on borrowing costs. Lane is the official who prepares monetary policy decisions for the 26-member governing council that sets rate benchmarks, whose other members are the heads of national central banks in the eurozone countries.
How fast the bank will reduce rates at subsequent meetings remains open. Recently better growth indicators for Europe as well as sticky 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 communication over the last two months has made it almost impossible not to cut,” Brzeski said. That means the bank may move “very gradually” after the June meeting to reduce rates while still keeping them at a level that restricts credit, growth and inflation.
