Why It Matters
Europe’s economy, though more resilient than many forecasters had predicted, has still significantly weakened over the past 12 months, with a drop in inflation-adjusted wages and consumer confidence. Growth is expected to pick up, but further increases in interest rates could act as a brake on the economy.
Gita Gopinath, first deputy managing director of the International Monetary Fund, said this week that an “uncomfortable truth” is that central banks must remain diligent about bringing down inflation rates “even if that means risking weaker growth.”
The same message is coming from the E.C.B., which has already signaled the likelihood of rate increases in July and September. Speaking this week at the central bank’s 10th annual conference in Sintra, Portugal, Christine Lagarde, the E.C.B.’s president, said: “Inflation in the euro area is too high and is set to remain so for too long.”
The rapid rate increases have drawn criticism from political leaders like Giorgia Meloni, Italy’s prime minister, who scorned “the E.C.B.’s simplistic recipe of raising interest rates” in a speech to Parliament on Wednesday.
Background
Inflation in the eurozone — whipped up by soaring energy and food prices last year after the coronavirus pandemic eased and Russia invaded Ukraine — peaked in October at 10.6 percent.
Price rises have been slowing across the eurozone since then. France’s annual inflation rate fell to 5.3 percent in June, from 6 percent in May. Italy’s rate fell to a 14-month low of 6.7 percent, down from 8 percent the previous month. Spain’s rate fell to 1.6 percent, the slowest since March 2021. Government subsidies of gas bills have helped keep the rate low.
Germany, the largest economy in Europe, saw a rise in its annual inflation rate to 6.8 percent, up from 6.3 percent in May. But analysts said the increase was almost entirely because of a reduction in subsidized rail fares that the government put into effect in June of last year. Inflation rates in Germany are expected to resume their fall in September.
Slovakia’s rate of 11.3 percent was the highest in the eurozone.
Despite expectations that inflation in Europe will continue to fall, the rate remains well above the central bank’s target of 2 percent. Efforts to achieve that goal led policymakers to raise interest rates, lifting the deposit rate to 3.5 percent in June, a 22-year high.
Before it began raising rates last year, the E.C.B.’s key policy rate was negative 0.5 percent.
Why is inflation so persistent?
Ms. Lagarde said this week that “this persistence is caused by the fact that inflation is working its way through the economy in phases, as different economic agents try to pass the costs on to each other.”
Although economists are often fixated by the risk of a wage-price spiral fueling inflation, recently there has been growing evidence that the pursuit of company profits has been pumping up prices despite significant drops in energy prices since last year’s peak.
“Rising corporate profits account for almost half the increase in Europe’s inflation over the past two years as companies increased prices by more than spiking costs of imported energy,” economists at the I.M.F. said this week.
“Europe’s businesses have so far been shielded more than workers” from rising costs, the I.M.F. noted. After adjusting for inflation, profits were above their prepandemic level while workers’ compensation was 2 percent below the trend in the first quarter of this year.
