European Central Bank officials are expected to cut interest rates this week for the first time in more than five years, ending the euro zone’s worst inflation crisis and easing pressure on the region’s weak economy .
But as euro zone policymakers move forward, they leave behind their counterparts at the U.S. Federal Reserve, who are grappling with a seemingly more persistent inflation problem and warning that it will take longer to bring it down rates.
Lowering interest rates in Europe before the United States would drive a wedge between the policies of two of the world’s largest and most influential central banks. A decision by the ECB to ease policy could weaken the euro, while higher interest rates in the United States would continue to tighten financial conditions there and other countries due to the global role of the dollar.
Some analysts question the extent to which the ECB can separate from the Federal Reserve, while others say a divergence is not unusual and reflects two different economic situations.
“We are emerging from more than a year of stagnation” in Europe with signs that disinflation is on track, said Mariano Cena, an economist at Barclays. “That’s a very low starting point for an economy.”
In contrast, the US economy has been booming in recent quarters.
“There have already been divergences between economies,” he said. “So if there are divergences in policies, it’s because they follow the different trajectories of the economies.”
Although the ECB has stressed that it does not act simply on the basis of what the Fed does, policymakers recognize that they cannot ignore the the influence of the Fed on financial conditions and exchange rates around the world.
“Monetary policy operates in a global context,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management. “If the global context changes because of the United States, China, tariffs or anything else, then the ECB must take this into account.”
The ECB clearly announced its intention to lower its key interest rate this Thursday, bringing it from 4% to 3.75%, the highest level in the history of the central bank and its level since September. Inflation is expected to return sustainably to the bank’s 2% target next year as the shock of high energy prices following Russia’s invasion of Ukraine fades.
The block inflation rate was 2.6 percent in May, slightly higher than the previous month, but has slowed significantly from its peak of above 10 percent at the end of 2022.
The euro zone economy is still reeling from high interest rates put in place to combat high inflation. Its growth was only 0.3% in the first quarter of the year after five quarters of stagnation, the manufacturing sector is contracting and the demand for loans to expand businesses and buy homes has declined significantly.
But in the United States, Fed officials are having more difficulty controlling the economy, where inflation is driven by strong demand. THE The consumer price index rose 3.4 percent in April compared to a year earlier.
“What the two regions have in common is that there is uncertainty” about the inflation outlook, Ducrozet said. But, he added, “the arguments in favor of divergence remain very strong.”
The ECB and the Fed have diverged in the past, such as in the years before and after the 2008 financial crisis. In 2014, as Europe grappled with deflation and the region’s sovereign debt crisis, the he gap widened for another five years when the ECB introduced negative interest rates and a large bond buying program.
This time, the divergence is expected to last only as long as it takes for the Fed to start cutting rates. The two central banks should not move in opposite directions, especially after a measure of American inflation in April provided welcome signals of a slight slowdown in prices and consumer spending.
That would allay one of investors’ biggest concerns about the ECB’s lead over the Fed: that the euro could weaken against the U.S. dollar and that the region would import inflation through its exchange rate. If the ECB meets traders’ expectations, the exchange rate should not move much, Cena said.
The ECB is expected to make only a few rate cuts this year, a quarter-point reduction once a quarter, which would restrict the economy. This cautious approach is justified: inflation in the euro zone services sector, a stubborn category heavily influenced by wages, accelerated to 4.1 percent in May, from 3.7 percent the previous month .
“It’s something that has raised eyebrows,” said Jumana Saleheen, chief European economist at Vanguard.
Services inflation is not showing much sign of slowing. “It’s worrying but not alarming,” said Saleheen, who added that other components of inflation, such as food and goods, had slowed significantly. She expects the ECB to cut rates three times this year.
“In general, it’s good news,” she said. “In Europe, the worst is over, we have put an end to stagnation and we are now heading towards a period where we can return to trend growth.”
Still, analysts say there are limits to how far the ECB could go without the Fed.
“The longer you delay the Fed’s cuts, the more difficult it may be for the ECB in the long run,” Mr. Ducrozet said, adding that the situation would become more difficult “if the Fed does not cut at all or, even worse, if She’s starting to cut back on her spending.” We are very concerned that the elections will lead to a new wave of inflationary pressures.”
