ECB Poised to Hold Rates Steady but Hints at Potential Hike to Tame Inflation
ECB's Approach to Interest Rates Amid Surging Inflation
By Balazs Koranyi and Francesco Canepa
FRANKFURT, April 30 (Reuters) - The European Central Bank will keep interest rates unchanged on Thursday like most of its global peers this week, but it is also likely to signal that a rate hike, perhaps as soon as June, may be needed to combat an energy-driven consumer price surge.
Inflation has soared well above the ECB's 2% target level since the start of the Iran war and policymakers are nervously watching to see whether this rise becomes embedded in the economy, creating second-round price effects that make rapid inflation self-sustaining.
Current Economic Indicators and ECB's Response
Such secondary effects are yet to become visible, however, and the services sector, a key driver of prices in the past, is cooling more than some had predicted, easing pressure on the ECB to act and giving policymakers more time to sift through data that have not fully captured the impact of the war.
Still, any rate hike delay is likely to be short-lived and investors expect a move in June, followed by two more hikes this year as peace in Iran seems increasingly distant and oil prices are above $110 a barrel, approaching levels seen in the ECB's "adverse" scenario.
ECB Must Send a Signal
"Essentially, the ECB wants to signal to price and wage setters that it's alert and will not let inflation get embedded," Morgan Stanley economist Jens Eisenschmidt said.
"These hikes wouldn't fundamentally change the interest rate environment," Eisenschmidt added. "They would essentially move the deposit rate from broadly neutral to the upper range of neutral."
Growth Concerns and Policy Dilemma
Rapidly cooling economic growth creates a dilemma, however.
The ECB needs to fight inflation but any policy tightening risks hampering already fragile growth, increasing the risk of it pushing the bloc into recession.
Indeed, a slew of surveys this week showed that business sentiment is plunging quicker than predicted, the services sector is deteriorating, corporate profits are dropping, exports are still reeling from tariffs, and banks plan to curtail firms' access to credit.
Market Expectations and Inflation Outlook
Not in a Great Hurry
But these same surveys showed that both consumers and businesses expect inflation to accelerate.
Indeed, data due just hours before the ECB's policy announcement are expected to show inflation rising to 2.9% in April across the 21-nation euro zone from 2.6% in March, well above the bank's 2% target.
Potential for Second-Round Effects
"There are high chances of second-round effects," BNP Paribas Chief Economist Luigi Speranza said. "The probability that some of the increase in energy prices, in food prices propagates and spills over to core inflation in a more perceived way is really high."
Still, policymakers seem to be in no hurry to fight back.
Global Central Bank Trends
The Bank of Japan, the U.S. Federal Reserve and the Bank of Canada all left interest rates unchanged this week, and the Bank of England is expected to do the same on Thursday.
ECB policymakers have also said that the six weeks between meetings make very little difference, so it pays off to wait for more hard data before pulling the trigger.
Comparisons to Previous Inflation Surges
This is especially true since the current inflationary episode is not comparable to the 2022 surge, when the ECB was arguably late in acting.
Inflation was far higher then, interest rates were still in negative territory, government budgets were loose, labour markets were tighter and households were sitting on ample savings, ready to spend the cash they collected during pandemic lockdowns.
Forecasts for Future ECB Moves
"We believe that, if the spot price of Brent crude oil were to remain above $95 per barrel by the ECB's June meeting, the ECB would raise rates by 25 basis points in June and then again in September," Nomura said.
"For the ECB to raise rates, we believe the Governing Council will want to see the shock is causing persistently higher inflation, as in 2022, or that the shock meaningfully raises inflation expectations," it added.
(Reporting by Balazs Koranyi; Editing by Hugh Lawson)