The European Central Bank is expected to raise its key interest rate to the highest level in 22 years, while warning that underlying inflationary pressures are proving thornier than it had hoped.
The outcome of Thursday’s meeting of the ECB’s Governing Council will underscore that most of its rate-setters still see the risk of raising rates too little outweighs the downside of potentially tightening monetary policy too much.
However, the ECB may signal that it is nearing the end of its unprecedented rise in euro zone borrowing costs after the Federal Reserve paused its 10th straight rate hike on Wednesday.
Euro zone rates remain lower than in the U.S., with ECB rate-setters broadly agreeing on the need to raise its main policy rate for the eighth time on Thursday, which would lift the deposit rate by 25 percentage points to 3.5%, the highest level since 2001 July.
European Central Bank executive board member Isabel Schnabel explain This month: “The cost of doing too little remains higher than the cost of doing too much, given the high level of uncertainty over persistent inflation.”
Headline inflation in the euro zone has fallen to 6.1% in May from a peak of 10.6% in October. But that was largely due to lower energy prices, which are still well above the ECB’s 2% target.
The central bank has said it won’t stop raising rates unless underlying inflation, which excludes volatile factors like energy and food, falls markedly.
While some measures of underlying inflation in the euro zone fell for the first time in May, this mainly reflected the introduction of a €49-a-month public transport subsidy in Germany.
ECB President Christine Lagarde explain Earlier this month, there was still “no clear evidence that underlying inflation has peaked” and warned that “increasing wage pressures are becoming a more important driver of inflation”.
According to data released by the European Central Bank last week, per employee compensation in the euro zone rose by 5.2% year-on-year in the first quarter, up from 4.8% in the fourth quarter.
When the ECB releases new quarterly growth and inflation forecasts on Thursday, those are expected to reflect higher wage growth and stickier service prices. Barclays economist Silvia Ardagna predicts that the ECB will raise its core inflation forecast, which excludes energy and food prices, to 5% this year from 4.6%.
This summer, travel bookings and consumption in Mediterranean countries such as Spain are expected to rebound above pre-pandemic levels. That will lead to a further surge in prices for flights, hotels and package holidays, which have already risen by double digits over the past year.
Mark Wall, chief economist at Deutsche Bank, predicts that a strong tourist season could be enough to reverse a near-term decline in underlying price pressures — not just at the rate-setter’s July meeting, but also in September.
Other ECB watchers, however, see only one more rate hike after this week as the debate over the trade-off between inflation and growth becomes more balanced.
Doves urged more caution after revised official data showed the euro zone economy shrank in the past two quarters. “We will feel our monetary tightening in the coming months,” ECB board member Fabio Panetta said, adding that this could “translate into a prolonged downturn in economic activity, or even a technical recession.”
Eurozone retail sales were down Adjusted for inflation, it was up 2.6% year-over-year in April.The group’s industrial production has barely grown over the past year and is likely to decline in april Ireland’s output will not jump substantially due to the transfer of intellectual property by multinational companies.
The ECB cut its growth forecast for 2023 from 1% forecast in March, and is expected to reflect a more pessimistic forecast for growth.
“The economy is already in a mild recession, inflation is falling, global headwinds are hitting manufacturing and credit flows are starting to contract,” said Holger Schmieding, chief economist at Berenberg Bank. “The recent news flow strengthens the dovish case against further tightening.”
But after being widely criticized for being too late to respond to last year’s surge in inflation, the ECB appears determined to keep raising rates until there is no doubt that price growth is firmly on track to its 2 percent target.
“The Governing Council once misjudged inflation once and therefore would not bet that the hikes so far will be enough,” said Stefan Gerlach, former deputy governor of the Central Bank of Ireland.