Stubborn inflation keeps ECB on course for more rate hikes

By Francesco Canepa

The drop in inflation of the euro zone in March was the largest on record; however, “core” prices grew faster, which strengthens the case for more interest rate hikes by the European Central Bank (ECB).

The ECB has not committed to further rate hikes following a record streak of increases. Instead, the bank will depend on whether the current turmoil in the banking sector subsides and on data, including underlying inflation, which excludes volatile prices such as food and energy.

The data released on Friday showed that underlying inflation grew to a new record high this month, even as the broader headline figure fell sharply and consumers became more cautious.

Commerzbank economist Christoph Weil said, “The pressure on the ECB to continue raising interest rates remains high.”

In March, consumer prices in the euro zone rose by 6.9%, indicating the largest drop since Eurostat began collecting data in 1991. However, the fall was mainly due to lower energy prices compared to March last year when they had surged in the wake of Russia’s invasion of Ukraine.

A measure known as core inflation, which excludes energy and food prices and is a better gauge of the underlying trend, accelerated to a new all-time high of 7.5% from 7.4% in February.

Reuters analysts had expected headline inflation in the 20 countries that share the euro to come in at 7.1% and core inflation at 7.5%.

However, data on Friday from the two largest euro zone economies pointed to a softening of consumers’ ability to spend, which is ultimately the main driver of price growth.

French consumer spending fell unexpectedly in February, as did German retail sales, while a European Commission survey published a day earlier showed that households want to save more.

German import prices also registered their smallest increase in two years in February as energy prices eased.

Dirk Schumacher, an economist at Natixis, said, “That is, all else equal, disinflationary and it argues that the ECB doesn’t have to do much more.”

Money-market prices show that investors expect a 25-basis-point rate hike by the ECB at its next meeting on May 6, followed by another one or possibly two of the same size over the summer.

Euro zone unemployment remained stubbornly low at 6.6%, strengthening the case for more tightening. Policymakers fear that low unemployment could give workers greater bargaining power in salary negotiations and lead to higher wage increases that could perpetuate high inflation.

German bank Deka economist Ulrich Kater said, “This sediment of inflation will not be flushed out for two or three years, and will require further moderate interest rate increases by central banks, regardless of the current banking stress.” Several ECB policymakers, including chief economist Philip Lane, have also said recently that more increases in borrowing costs are likely needed to bring inflation back to the bank’s 2% target.

(Additional reporting by Frank Siebelt; Editing by Catherine Evans)

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