European Central Bank (European Central Bank) decided to cut interest rates on June 6, but the decision was not unexpected. Interest rate futures data over the past few weeks had suggested a rate cut was all but certain.
However, Austria's decision to vote against the cuts European Central Bank One problem that will have to be addressed sooner or later is the wide variation in inflation rates among eurozone member states, despite the central bank's target of a weighted average inflation rate of 2%.
In Austria, inflation is currently around 4%, which helps explain the country's resistance to inflation. European Central BankBut Italy's inflation rate is already below 1 percent and other euro zone economies, such as Lithuania, are heading toward deflation.
Meanwhile, France and Germany have maintained high interest rates and 2%-plus inflation for some time. european unionThe two largest economies had inflation rates similar to Austria's. European Central Bank They wouldn't have lowered interest rates.
When assessing the competitiveness of euro area member states, one should not underestimate the inflation differences that exist between countries that share the same currency. Countries with the highest inflation are generally at a disadvantage: they have higher capital costs, higher production costs and commodity prices, which means they face the risk of crowding out, especially for companies that produce perfect substitutes.
This dynamic is further exacerbated by the fact that the euro is a stateless currency, which has led to increased levels of credit risk in some eurozone member states, resulting in risk inequality across the eurozone – again, putting countries with the highest interest rates at a competitive disadvantage.
New continent, old problems
The problems with using a weighted average approach to setting central bank inflation targets are not unique to the eurozone: in the US, inflation in Pennsylvania is just under 2%, while in Florida it is around 4%, the highest in the country. But the big difference between the US and the eurozone is that the Federal Reserve is well aware of the problem, and the substantial size of the US national budget allows for appropriate transfer policies to mitigate the risks.
In any case, the ECB's rate cut will be a clear benefit to the euro area due to the fact that it has made clear the decoupling of US and euro area inflation. The rise in US inflation and the fall in euro area inflation over the past few months prove that the two inflation trends have structurally different determinants. The theory of a four-month lag between US and euro area inflation trends no longer seems valid.
It is clear that the rise in inflation in the United States was primarily due to an increase in aggregate demand resulting from expansionary fiscal policy and the trend toward full employment. Price increases were caused by increases in production levels, inventories, and wages.
In contrast, the rise in inflation in the Eurozone was the result of a reduction in aggregate supply due to the energy crisis after Russia's invasion of Ukraine. Structural changes in the energy supply chain since 2022 were effective in tackling the energy crisis. This paved the way for a decline in inflation, which in Europe reacted to global macroeconomic trends as most orthodox economists predicted. It is therefore not surprising that the ECB has set itself the goal of reaching its 2% target by 2026, a slightly longer period than the ECB had previously adopted.
Interest rate futures data shows the ECB is expected to make two more rate cuts by the end of the year. In contrast, Fed Funds futures data shows the market is expecting Do not move This scenario is likely to continue at least until the US presidential election in November.
Marcello Minenna is a civil servant and economist. The author can be contacted at marcello@minenna.it
Edited by: Daniel Blackburn
