Europe’s inflation rose in May, but a central bank rate cut is still likely next week

According to official figures released on Friday, inflation in Europe rose to an annual rate of 2.6% in May. This increase was higher than anticipated, as the decline in consumer prices has been slow. Despite this rise, it is unlikely to prevent the European Central Bank (ECB) from making its first interest rate cut next week, potentially moving ahead of the U.S. Federal Reserve in reducing borrowing costs for businesses and consumers.

However, the higher inflation figure suggests that the ECB may not follow up next week’s expected rate cut with another one at its July meeting. The 2.6% inflation rate for the 20 countries using the euro compares to 2.4% in April, with market expectations set at 2.5% for May, according to Eurostat, the European Union’s statistics agency.

In contrast, the U.S. Federal Reserve has been hesitant to cut rates due to more persistent inflation in the U.S., which was at a seasonally unadjusted annual rate of 3.4% in April. This marks a reversal from the previous cycle, where the ECB was slower than the Fed in raising rates as inflation surged globally. The ECB now faces a different economic landscape, having been more severely impacted by a spike in energy prices, which has since diminished.

Inflation in Europe soared into double digits after Russia reduced its natural gas pipeline supplies following its invasion of Ukraine, exacerbated by supply chain disruptions post-pandemic. Although inflation has decreased as energy prices fell and supply chain issues eased, the decline has slowed recently. This is due to workers demanding higher wages to compensate for lost purchasing power, leading to persistently high prices in the services sector, which includes costs like hotel stays, medical care, and entertainment. Services prices rose by 4.1% in May, while energy prices increased marginally by 0.3%, and food inflation matched the overall rate at 2.6%.

With inflation nearing the ECB’s target of 2%, concerns about economic growth have become more significant. The eurozone has seen no notable GDP growth in four years. While higher interest rates can curb inflation by making borrowing and spending more expensive, they can also hinder economic growth.

ECB officials have indicated that a rate cut from the current record high of 4% is under consideration when the bank’s governing council meets in Frankfurt. ECB President Christine Lagarde recently expressed confidence that inflation is under control. Philip Lane, a member of the ECB’s executive board, mentioned that officials are prepared to ease borrowing costs, as reported by the Financial Times. Lane is responsible for preparing monetary policy decisions for the governing council, which includes the heads of national central banks in the eurozone.

The pace at which the ECB will reduce rates in subsequent meetings remains uncertain. Carsten Brzeski, global head of macro at ING bank, noted that recent positive growth indicators and persistent inflation could argue against a rate cut next week. However, the ECB’s recent communications suggest that a cut is likely, though the bank may proceed cautiously and gradually after the June meeting to maintain credit, growth, and inflation control.

Riccardo Marcelli Fabiani, senior economist at Oxford Economics, predicted that the ECB would be cautious and is unlikely to lower interest rates at the July meeting.