Euro zone inflation rose to 2.6 percent year-on-year in May, official figures showed on Friday, but a painful surge in consumer prices will take some time to subside.
The larger-than-expected hike is unlikely to stop the European Central Bank from cutting interest rates for the first time next week, moving ahead of the Federal Reserve in lowering borrowing costs for businesses and consumers.
Still, rising inflation will likely make it less likely that the ECB's first rate cut next week will be followed immediately by a further cut at its July meeting.
The official figure for the 20 countries that use the euro compares with 2.4% growth in April, according to Eurostat, the European Union's statistics office. Markets had expected 2.5% growth in May.
“These numbers strengthen the case for those who say we need to be cautious,” said Dirk Schumacher, an economist at Natixis.
The ECB will go ahead of the Fed, which has refrained from cutting interest rates due to lingering U.S. inflation. This marks a shift from a cycle of rate hikes in which the ECB lagged the Fed in raising rates when inflation erupted in the world's developed economies. U.S. consumer price inflation rose to an unadjusted annual rate of 3.4% in April.
In this case, the ECB faces a different economic situation, as it was heavily impacted by high energy prices, the effects of which have now subsided. The Fed is in a different situation, as inflation in the US has been fuelled by higher stimulus spending and stronger growth during and after the coronavirus pandemic.
Inflation in Europe soared into double digits after Russia invaded Ukraine, cutting off most pipeline supplies of natural gas, and the pandemic recovery stalled supply chains for parts and raw materials. Inflation has since eased as energy prices have fallen and supply disruptions have eased.
The decline in inflation has slowed in recent months as workers have pushed for higher wage deals to make up for eroding purchasing power, keeping prices high in the service sector, which includes everything from hotel rooms to health care to concert tickets, where wages make up a large portion of business costs.
Services prices rose 4.1% in May, while energy prices rose just 0.3%, keeping overall food inflation at 2.6%.
Concerns about growth have become more pronounced as inflation approaches the ECB's 2% target. The euro zone has not seen a significant increase in gross domestic product in four years. Higher interest rates can combat inflation by making it more expensive to borrow money and buy goods, but they can also drag down growth.
ECB officials have said a cut in interest rates from their current record high of 4% is on the table when the bank's interest rate governing council meets in Frankfurt, and President Christine Lagarde said last week she was “really confident” that inflation was under control.
Philip Lane, a member of the six-person executive board that runs the bank's day-to-day operations from its Frankfurt headquarters, said regulators were “ready to remove the top-tier limit” on borrowing costs, the Financial Times reported.
Rehn is the official who prepares monetary policy decisions for the 26-member Governing Council, which sets the benchmark for interest rates. The other members of the Governing Council are the heads of euro zone central banks.
Fabio Panetta, a European Central Bank policymaker and governor of the Bank of Italy, said the latest data was neither good nor bad and reaffirmed his view that central banks can keep the brakes on the economy by cutting interest rates a few times.
It is not clear how fast the central bank will cut rates at its upcoming meetings. Recent improvements in European growth data, solid inflation and strong wage growth “could provide a case against a rate cut next week,” said Carsten Brzeski, global head of macro at ING Bank.
“But the ECB's own communication over the past two months has made it almost impossible not to cut rates,” Brzeski said. That means the ECB could cut rates “very gradually” after its June meeting, while keeping them at levels that will keep credit, growth and inflation in check.
Riccardo Marcelli Fabiani, senior economist at Oxford Economics, said the central bank “will tread cautiously and is unlikely to cut rates at its July meeting.”
