why it matters
Europe’s economy, although more resilient than many forecasters, has still weakened significantly over the past 12 months, with a decline in inflation-adjusted wages and consumer confidence. Growth is expected to pick up, but a further hike in interest rates could act as a brake on the economy.
Geeta Gopinath, The International Monetary Fund’s first deputy managing director said this week that an “inconvenient truth” is that central banks must be diligent in bringing down inflation “even if it means risking weak growth.”
That’s the message coming from the ECB, which has already signaled the possibility of rate hikes in July and September. Speaking at the central bank’s 10th annual conference in Sintra, Portugal this week, ECB President Christine Lagarde said: “Inflation in the euro area is very high and will remain so for a very long time.”
The rapid rate hike has been criticized by political leaders such as Italian Prime Minister Giorgia Meloni, who scorned “the ECB’s simple method of raising interest rates”. in a speech in Parliament on Wednesday.
Lucrezia Reichlin, a professor at the London Business School and former director general of research at the ECB, said raising rates in September “would be a mistake”. “It is a misconception that core inflation is demand-driven,” he said, but noted a modest increase in June. The result is the time lag between the effect of previous rate hikes and the significant decline in energy prices.
Riccardo Marcelli Fabiani, an economist at Oxford Economics, said a modest increase in core inflation does not mean that the deflation process has stopped. He said inflation in the services sector declined in France and Italy, which is “one of the growing signs that deflationary pressures are building up.”
background
Inflation in the eurozone – boosted last year by the easing of the coronavirus pandemic and a spike in energy and food prices following Russia’s invasion of Ukraine – hit 10.6 percent in October.
Since then, price increases have been slowing across the eurozone. France’s annual inflation rate fell to 5.3 percent in June from 6 percent in May. Italy’s rate dropped to a 14-month low of 6.7 percent from 8 percent last month. spain rate fell 1.6 percentSlowest since March 2021. Government subsidy of gas bills has helped keep the rate low.
The annual inflation rate in Germany, Europe’s largest economy, rose to 6.8 percent from 6.3 percent in May. But analysts say the hike is almost entirely due to the cut in subsidized rail fares, which was implemented by the government in June last year. Inflation in Germany is expected to resume its decline in September.
Slovakia’s rate of 11.3 percent was the highest in the euro area.
Despite expectations that inflation will continue to decline in Europe, the rate remains well above the central bank’s target of 2 percent. Efforts to achieve that goal prompted policymakers to raise interest rates, causing the deposit rate to rise to 3.5 percent in June, a 22-year high.
Before it started raising rates last year, the ECB’s key policy rate stood at negative 0.5 percent.
Why is inflation so persistent?
Ms Lagarde said this week that “this persistence is due to the fact that inflation is working its way through the economy in stages, as different economic agents try to pass on costs to each other.”
Although economists are often concerned with the risk of a wage-price spiral fueling inflation, there has been growing evidence recently that companies are looking for profits despite the significant drop in energy prices since last year’s peak. Prices are rising.
“Nearly half of Europe’s inflation increase over the past two years has been due to increased corporate profits, as companies increased prices more than the increase in the cost of imported energy,” the economists said. IMF said this week,
“Europe’s businesses have so far been more shielded from rising costs than workers”, the IMF said. After adjusting for inflation, profits were above their pre-pandemic levels, while workers’ compensation was down 2 percent from the trend for the first quarter of this year.
