Brussels, January 6 (BNA): Inflation eased in the eurozone last month but underlying price pressures are still rising and indicators of economic growth are surprisingly benign, suggesting that the European Central Bank will continue to raise interest rates for the coming months.
In the face of historically high rates, the European Central Bank has since July increased borrowing costs at the fastest pace ever. And it has promised a series of additional moves this year to curb inflation that economists say will stay above its 2% target through 2025, Reuters reported.
Eurostat data on Friday showed that consumer price growth in the 19 countries using the euro slowed to 9.2% in December from 10.1% in the previous month – well below a Reuters poll forecast of 9.7%, with the drop driven by lower energy prices.
The eurozone has since expanded to include 20 countries, and Croatia joined on January 1st.
But the headline number masked an insidious trend, with all major components of core inflation accelerating.
Excluding volatile food and energy prices, inflation rose to 6.9% from 6.6%, while a narrower measure that also excludes alcohol and tobacco rose to 5.2% from 5%.
Inflation in services and non-energy industrial goods, both of which are closely watched by the European Central Bank to gauge the continuity of price growth, has accelerated, adding to concerns that inflation is proving more stubborn than expected.
“Higher core inflation means it will not affect the ECB as much from the hawkish path it took late last year,” said Bert Collin, an economist at ING Bank.
A series of other indicators also suggest that the EU winter recession will be milder than expected, leaving the ECB with more work to do to tame prices.
The main economic sentiment indicator improved more than expected while retail sales data also showed surprising resilience.
Exceptionally mild weather, which implies lower consumption of costly energy, will help by supporting the purchasing power of households and preserving business margins.
But this may complicate life for the European Central Bank.
The recession was expected to cause unemployment to rise, which naturally reduces price pressures. But employment, which is already at a record level, is going up, not down.
Fiscal support to households has also proven to be more generous than expected, and this excessive spending increases purchasing power, burdening the ECB’s restrictive policies.
“The late crossing of higher production costs and a still-strong labor market will keep core inflation in check,” said Riccardo Marcelli Fabiani of Oxford Economics.
“With core inflation at record highs and likely to remain elevated over the coming months, we expect the ECB to make two 50 basis point hikes in February and March and then pause amid subdued inflation and declining economic trends.”
Although inflation may rise again in January, it is likely that the peak has passed and the ECB’s focus will begin to shift to the speed at which it will decline.
Markets and surveys are starting to factor in the possibility of price growth staying longer above 2% and even the ECB’s forecasts, which have proven overly optimistic over the past two years, don’t see the bank reaching its target until late 2025.
The problem is that the longer inflation stays high, the more difficult it will be to tame it as firms begin to adjust pricing and wage policies, thus perpetuating price pressures.
This is why the European Central Bank raised interest rates by 2.5 percentage points last year – mirroring its global peers, even if somewhat late – and promised to raise interest rates in both February and March which are set to raise the deposit rate to about 3%.
“We expect the deposit rate to be 3.25% in the spring, when it will likely remain for some time after that,” said Ralph Solvin of Commerzbank.
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