Frankfurt Inflation rates of 15 percent in the Baltic States, but below 5 percent in Spain, Belgium or Luxembourg: the large differences in the euro area make the work of the European Central Bank (ECB) more difficult. In some states, the price pressure is easing noticeably. But there are still euro countries with double-digit inflation rates.
These values clearly indicate that the ECB will raise interest rates again on Thursday. Then the council members come together for their next meeting.
On average, inflationary pressure increased again slightly in April. Consumer prices rose by 7.0 percent compared to the previous year, as the European statistical office Eurostat announced on Tuesday based on an initial estimate. In March, the value was 6.9 percent.
Core inflation is also still stubbornly high. This price increase adjusted for energy and food was 5.6 percent after 5.7 percent in March.
For the European Central Bank, the numbers imply a difficult starting position before its next Council meeting this Thursday. Most experts expect a small rate hike of a quarter of a percentage point. But a stronger rate hike is also considered possible. In the following, the Handelsblatt explains the key factors behind the differences in inflation and the consequences for monetary policy.
High inflation in the Baltics: Consequential dependency
The still extremely high inflation rates in the Baltic states are driven by energy and food prices. In many other economies, at least the rise in gas and electricity prices has meanwhile slowed significantly. However, the Baltic States continue to record high inflation rates.
Before the start of the Ukraine war, Estonia, Latvia and Lithuania were heavily dependent on energy and food imports from the neighboring countries of Russia, Belarus and Ukraine. When the war started, they had to look for alternatives – which are significantly more expensive.
The sharp increase in energy and food prices is also more noticeable in the Baltic States because incomes there are lower than the EU average. As a result, people spend a larger part of their income on it. The proportion of the shopping basket is therefore larger there.
However, improvement is in sight. In Latvia, for example, according to a forecast by the national central bank, inflation should again reach the ten percent mark. According to the central bank’s most optimistic scenario, the figure could return to single digits as early as the second half of the year.
However, the relief of the Latvians is likely to be particularly great when they look at the energy bills. In the winter months, gas bills of 300 to 400 euros for a two-person household were not uncommon.
Now the municipal heating company Siltums in the capital Riga has announced that heating costs will drop by around 45 percent from May 15. Electricity prices are also gradually falling. The Ministry of Climate and Energy attributes this to the increase in the share of renewable energies on the one hand and the commissioning of a new nuclear power plant in Finland on the other.
Low inflation in Spain, Belgium and Luxembourg
In contrast, April inflation was particularly low in countries such as Spain (3.8 percent), Belgium (3.3 percent) and Luxembourg (2.7 percent). This is also due to the composition of the shopping cart. Unlike in the Baltic States, the share of food and energy is lower here. Due to the different composition of the shopping baskets, the inflation rates in the euro countries are different even if all prices were to rise at the same rate.
Another important factor are government measures to curb energy prices. France, for example, was the country with the lowest inflation rates for a long time. Because there the state capped electricity prices earlier than elsewhere. Other countries followed later.
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However, some of the countries where electricity prices rose particularly sharply in 2022 are now seeing a decline. For example Spain. This is also due to the base effect: Because electricity prices rose so sharply last year, the values with which the current figures are compared are very high.
This results in a minus in some countries. However, this also depends on how quickly electricity prices are adjusted, as the example of the Baltic States shows.
Other state aids also play a role. For example, the Spanish government has reduced VAT on essential foods such as bread, cheese, fruit and vegetables from four to zero percent. In Germany, too, inflation should be dampened in May by the introduction of the 49-euro ticket for local transport.
The extreme differences in inflation figures across countries make analyzing inflation even more complicated. This makes the work of the ECB more difficult. The central bank must take the different causes of inflation into account when setting interest rates. The interest rate you choose then applies to the entire euro area. If the central bank were only responsible for the Baltic countries, it would probably have to raise interest rates much more than if it were only the central bank of Spain or Luxembourg.
Small rate hike expected
Most economists expect the ECB to raise interest rates by a quarter of a percentage point on Thursday. Commerzbank economist Christoph Weil sees the continued stubborn core inflation as an argument for further tightening of monetary policy. “The pressure on the ECB remains high to raise key interest rates further.” Weil assumes that companies have meanwhile passed on a large part of the energy price-related increase in production costs to consumers.
Now, however, a new wave of costs is imminent with the sharp rise in wages. The collective bargaining parties in the public sector in Germany recently agreed on significant wage increases. On average, wages and salaries are expected to increase by around eleven percent from March 2024. The chief economist at KfW, Fritzi Köhler-Geib, takes a similar view. However, she is assuming a switch to smaller interest rate steps of 25 basis points. Most recently, the ECB raised the key interest rate by 50 basis points in March, which means that it is now 3.5 percent in the euro area. The deposit rate that banks get on excess deposits they hold with the central bank is 3.0 percent.
The US Federal Reserve is already meeting on Wednesday ahead of the ECB meeting on Thursday. Investors expect it to hike rates another 25 basis points. This would increase the key interest rate in the USA to the range of five to 5.25 percent. This could already be the high point. In contrast, most experts expect that the ECB still has a long way to go.
Supporters of a small rate hike by the ECB also point to the results of the new survey on credit conditions in the euro area, which the central bank also published on Tuesday. Accordingly, the banks restricted lending more than expected in the first quarter. According to central bank experts, this points to a “continued weakening of credit dynamics”.
The economist at asset manager Pictet, Frederik Ducrozet, sees the data as a signal that monetary policy is working. He expects that the interest rate hikes so far will have further effects. In his view, the ECB should therefore act more cautiously and limit interest rate hikes to small steps of 25 basis points.
It is likely that the ECB President will announce a rate hike of 25 basis points on Thursday.
(Photo: dpa)
There were different tones from the Governing Council ahead of Thursday’s meeting. Isabel Schnabel, who is a member of the ECB leadership, recently emphasized in an interview with the magazine “Politico” that the size of the rate hike depends on the incoming data. Even an increase of half a percentage point is “not off the table”.
Chief economist Philip Lane, on the other hand, did not comment on the amount of the next rate hike. All he said was that the data indicated that interest rates should be raised further.
France’s central bank governor François Villeroy de Galhau stressed that the ECB has “gone most of the way” in tightening monetary policy. “A few more increases might be needed, but I think they should be limited in number and now in scope,” he said.
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