Will fresh eurozone inflation data dampen rate cut hopes?

For many who have been waiting impatiently for the one key European Central Bank announcement after a protracted period of high interest rates, fresh EU data released on Friday (31 May) may have just killed the mood.

Eurostat, the EU’s statistics office, showed that inflation data slightly overshot expectations this month, with the headline rate rising to 2.6% from 2.4% in April. Economists polled by Reuters had predicted an inflation rate of 2.5%.

Core inflation, which strips out volatile food and energy costs and is widely considered a better gauge of underlying price pressures, increased from 2.7% to 2.9% while analysts had expected it to remain flat.

The new data threatens to dampen prospects for a continued rate cut trend beyond next week – when the ECB is all but certain to rein in its headline rate –  as most had hoped to see the central bank kick-start a new phase of cutting interest rates.

Beside, inflation has proven to be significantly stickier than many have expected this year, with the headline rate remaining stubbornly above the ECB’s 2% target despite interest rates currently being at record levels.

The ECB’s decision next week also comes amid a stagnating eurozone economy, which analysts have noted could benefit from the “momentum injection” provided by a rate cut.

However, it also comes amid growing concerns about the possibility of ECB policy “diverging” from that of the US Federal Reserve — with inflation across the Atlantic proving to be even stickier than in Europe.

In particular, many analysts have warned that the ECB’s decision to cut rates before the Fed could lead to the euro depreciating against the dollar, thereby driving up the price of imports and, ultimately, prices in general.

Prior to today, financial markets had priced in just one further rate cut beyond June, down from a total of six predicted at the start of 2024. This remained the same following the data’s release this morning.

Thus, today’s data almost certainly won’t change the ECB’s decision next week — or likely even this year. Whether it will change what happens beyond 2024, however, remains an open question.

Chart of the Week

Aggregate trade data from the World Bank and the OECD shows that trade with global partners accounts for a considerably larger slice of the EU’s economy than of the US’s and China’s counterparts.

Figures for the three decades to 2022 would thus corroborate that the 27-country bloc would indeed seem more committed to free trade principles, as stated by trade ministers on Thursday (see first article below), than its two global peers.

In 2022, trade as a percentage of GDP surged to an all-time record of 105% for the EU bloc, while it hoovered at 27% for the US and 38% for China.

Economic Policy Roundup

EU trade ministers reaffirm their support for free trade, despite signals from the US top trade official that Washington will largely renounce market mechanisms. Commission Executive Vice-President Valdis Dombrovskis said on Thursday (30 May) that “openness to trade” has contributed to “very substantial global economic development and has helped lift millions of people out of poverty”. “Trade will continue to play a very important role for EU’s competitiveness and prosperity,” he noted, adding that the EU should nevertheless be “mindful” of trade’s potentially “harmful” impact on the environment and labour rights. Dombrovskis was answering a question from Euractiv about US Trade Representative Katherine Tai’s remarks on Wednesday that “deferring to the market has its limits” and unrestricted free trade ultimately harms workers. Read more.

While EU policymakers hope to mobilise more private capital for investments through the Capital Markets Union (CMU), high capital requirements prevent insurance companies from “playing a bigger role”, industry association Insurance Europe warned on Thursday (30 May), calling for a revision of how the rules are calculated. Insurers have a large role in CMU plans, investing around €6.6 trillion a year in EU equities, corporate debt, and sovereign bonds. However, the industry group warned that the way capital charges are calculated, and the range of investments insurers can engage in, hinders their role in financing a broader set of assets and businesses. “The Solvency II review needs to deliver on its potential to address the […] framework’s current excessive capital [charges] and volatility, resulting in unnecessary barriers for long-term, guaranteed and profit sharing products,” the association wrote. “In the case of equities, [revising insurers’ capital treatment would] mean basing capital charges on the risk of long-term underperformance of the asset, and not only on a short-term trading risk approach,” the position paper adds.

Europe is facing a “generational shift” in its economic architecture that will cause inflation to be structurally higher than at any period since the early 1980s, two leading BNP Paribas economists say. Koen De Leus and Philippe Gijsels, chief economist and chief strategy officer at BNP Paribas Fortis, told Euractiv that rising public debt levels, geopolitical fragmentation, aging, and climate change will translate into quasi-permanent surging prices that will inevitably force central banks to keep rates at levels not seen in decades. While price stability should remain the ECB’s core official mandate, the two analysts expected that inflation of 3% will become “the new 2%” as the reference target. “This is a generational shift at the moment—and the last big one was at the beginning of the 1980s,” Gijsels said—referring to a period when former Federal Reserve Chairman Paul Volcker reined in the 1970s’ hyper inflation by hiking interest rates to a peak of 20% in 1981. Read more.

Putting up tariffs on Chinese electric cars to protect the European industry would be the wrong approach to promoting international competition, German liberal Transport Minister Volker Wissing told Euractiv in an interview. “Global competition is an incentive for German manufacturers to build better and cheaper cars,” Wissing told Euractiv. “I’m not worried that the German vehicle industry won’t survive this competition.” Wissing said he was “puzzled that some people are now calling for competition to be restricted by the state,” adding that “this has absolutely nothing to do with a market economy.” “In the end, you have to ask yourself: do we want to steer such a major transformation process according to the blueprint of the economically defunct GDR [German Democratic Republic], or do we stick with the successful model of the Federal Republic of Germany?”

European CEOs’ assessments of business conditions inside and outside of Europe diverge to the highest levels ever recorded. A survey published on Wednesday (29 May) revealed that European CEOs’ confidence in their companies’ prospects outside of Europe surged to a three-year high in the first half of this year, while expectations within effectively stagnated. “Leaders are optimistic for their companies’ investment and employment outside Europe—but within Europe, expectations are a lot less bright,” said Ilham Kadri, head of Syensqo and chair of ERT’s Committee on Competitiveness and Innovation. “As a place to do business, Europe seems stuck in a path of relative decline,” she added, warning, “Europe’s incoming leadership has to prioritise achieving a turnaround that puts competitiveness front and centre of the work programme from here to 2030.” Read more.

Right-wing arguments that Europe would need to sacrifice climate ambitions to boost competitiveness are groundless and increasingly rejected by business leaders, says Germany’s leading Green MEP. Rasmus Andresen, who also serves on the Parliament’s Committee on Economic and Monetary Affairs, explained that a growing number of company executives now recognise global warming’s disastrous long-term implications and expected negative impact on profits. “Big parts of industry and business are much further [ahead on climate policy] than some of the politicians within the EPP,” he said, referring to the centre-right group that is expected to retain its position as the most powerful parliamentary bloc after the European elections in June. Read more.

[Edited by Anna Brunetti/Zoran Radosavljevic]

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