European Central Bank officials are expected to cut interest rates this week for the first time in more than five years, drawing a line under the euro zone’s worst inflation crisis and ease pressure on the region’s weak economy.
But as policymakers in the euro zone move forward, they have left behind their counterparts at the US Federal Reserve, who are grappling with the problem of seemingly as more persistent and warned that it will take longer to cut interest rates there.
Lowering interest rates in Europe ahead of the United States would create a gap between the policies of the world’s two largest and most influential central banks. The ECB’s move to ease policy could weaken the euro, while higher interest rates in the United States would further tighten financial conditions there and in other countries because of the currency’s global role. dollars.
Some analysts have questioned how far the ECB can diverge from the Federal Reserve, while others say the divergence is not unusual and reflects two different economic situations.
“We are emerging from more than a year of stagnation” in Europe with signs that deflation is moving in the right direction, said Mariano Cena, an economist at Barclays. “This is a very low starting point for an economy.”
In contrast, the US economy has boomed over the past few quarters.
“There have been differences in the economies,” he said. “So if there are differences in policy, it is because it follows different trajectories of the economies.”
Although the ECB has emphasized that it does not act simply based on what the Fed does, policymakers acknowledge that they cannot ignore The Fed’s influence has on financial conditions and exchange rates around the world.
“Monetary policy operates in a global context,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management. “If the global landscape changes because of America, because of China, because of tariffs on anything, then the ECB has to take that into account.”
The ECB strongly announced its intention to reduce its key interest rate this Thursday, taking it from 4% to 3.75%, the highest level in the central bank’s history, and keeping it at this level since September. Inflation is expected to return sustainably to the bank’s 2% target next year as the shock to rising energy prices following Russia’s invasion of Ukraine subsides.
of blocks inflation rate was 2.6% in May, slightly higher than the previous month, but it has slowed significantly from its peak of above 10% in late 2022.
The euro zone economy is still reeling from the effects of high interest rates introduced to combat high inflation. It grew just 0.3% in the first quarter of the year after five quarters of stagnation, the manufacturing sector is shrinking and demand for loans to expand businesses and buy homes has dropped significantly.
But in the United States, Fed officials are having a harder time taming the economy, where inflation is fueled by strong demand. The Consumer price index increased by 3.4% in April compared with a year earlier.
“What both regions have in common is that there is uncertainty” about the inflation outlook, Mr. Ducrozet said. However, he added, “the case for divergence remains very strong.”
The ECB and the Fed have had different views in the past, such as in the years before and after the 2008 financial crisis. In 2014, as Europe struggled with deflation and a regional sovereign debt crisis, This gap widened again in five years when the ECB introduced negative interest rates and a large-scale bond buying program.
This time, the divergence is expected to last only until the Fed starts cutting interest rates. The two central banks are not expected to go in opposite directions, especially the latter US inflation measure in April gave some encouraging signs of modest declines in prices and consumer spending.
That would quell one of investors’ biggest concerns about the ECB getting ahead of the Fed: that the euro could weaken against the U.S. dollar and the region would import inflation through the exchange rate. exchange. If the ECB does what traders predict, the exchange rate will not fluctuate much, Mr. Cena said.
The ECB is expected to make only a handful of interest rate cuts this year, only by a quarter of a point once a quarter, which will still constrain the economy. There is justification for a cautious approach: Inflation in the euro zone’s services sector, a sector heavily influenced by wages, rose to 4.1% in May, from 3.7% last month.
“It’s something that raises eyebrows,” said Jumana Saleheen, chief European economist at Vanguard.
Services inflation shows little sign of slowing down. “It’s worrying but not alarming,” Ms. Saleheen said. She added that other components of inflation, such as food and goods, have slowed significantly. She expects the ECB to cut interest rates three times this year.
“Overall, it’s good news,” she said. “In Europe, the worst is over, we have ended the stagnation and are now moving to a stage where we can return to a growth trend.”
Still, analysts say there are limits to how far the ECB can go without the Fed.
“The longer you delay a Fed cut, the more difficult it will be for the ECB in the end,” Mr. Ducrozet said, adding that the situation would become more difficult “if the Fed doesn’t cut at all or – worse – if they start cutting back. There are real concerns that the election will lead to another wave of inflationary pressures.”
