The announcement by the United States Federal Reserve (Fed) last Wednesday (05/01/2024) that it would not lower interest rates in the short term was not a surprise. Over the past few months, inflation has steadily risen again, causing problems for authorities, central banks and investors, who were expecting several interest rate cuts over the course of 2024.
The panorama is not very different in Europe. Germany’s inflation rate rose more than expected in April, due to strong food and energy prices. This also reduced expectations that the European Central Bank (ECB) will make several rate cuts this year, as some experts expected.
These recent data “do not really resolve the question of the ‘last mile’. The news is not bad, but not as good as one might wish for,” Francesco Papadia, a member of the Bruegel think tank and former general director of market operations, told DW. of the ECB.
That last mile he is referring to is reducing inflation to a constant rate of 2%, a goal that European and US central banks have shared since addressing the global rise in inflation, which began in 2021 and peaked in late of 2022.
Inflation returns strongly
Between 2021 and 2023, the crises from Covid-19 to the war in Ukraine hit inflation rates around the world hard, reaching their highest levels in decades. Central banks responded with aggressive interest rate hikes.
Interest rates in the US are currently at their highest level in 23 years, between 5.25 and 5.5 percent, while in the eurozone, the ECB currently keeps rates at record highs of between 4 and 4.75 percent.
How central banks work
“Interest rates are the central bank’s main tool to influence the economy,” says expert Papadia.
“The mechanism is simple: if interest rates increase, investments decrease because the cost of financing them increases and consumption is affected, since people are more likely to delay spending,” he explains.
For central banks dedicated to economic stability, “interest rate changes are the most important tool,” he adds.
That helps explain why the Fed and ECB are currently so cautious about potential interest rate cuts. In late 2023 and early 2024, inflation rates were increasingly approaching the stated target of 2 percent and it seemed inevitable that the aggressive interest rate policy could be quickly reversed.
However, with inflation rising again, there are fears that rate cuts now could make the problem worse and push inflation even higher: “It is likely to take longer for us to gain confidence that we are on a sustainable path to inflation of 2 percent,” said Fed Chairman Jerome Powell.
European inflation vs. United States
In Europe, inflation appeared to be under reasonable control until April inflation data for Germany and Spain was released, showing increases of 0.5 and 0.7 percent, respectively, compared to March. However, ECB officials have strongly suggested they will lower rates for the first time in five years at their June meeting.
In the United Kingdom, outside the European Union (EU) but still part of the broader European economy, interest rate cuts are also expected soon: “I wouldn’t go so far as to say that inflation has been brought under control, but the “The outlook is certainly less worrying than it was in the middle of last year. We expect the Bank of England to start cutting interest rates in the summer,” Andrew Goodwin, chief economist at Oxford Economics in the United Kingdom, told DW.
While the inflation situations in Europe and the US mirror each other to some extent, a key difference, according to experts, is that European inflation has been largely influenced by energy prices, while in the US In the US, rising demand backed by a booming economy has pushed prices up again.
“The situation is different in the US, and the European economy does not show the same degree of dynamism as the American one,” highlights Papadia, a Bruegel expert.
(ct/ju)
