ECB hawks take aggressive stance on rates after UK inflation wake-up call

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The UK’s stubbornly high inflation has convinced senior policymakers at the European Central Bank to maintain their aggressive stance on raising interest rates to avoid being accused of failing to contain price pressures.

Several members of the ECB’s rate-setting governing council told the Financial Times that recent criticism of the Bank of England over its struggle to bring down inflation had served as a cautionary tale during private discussions at their annual conference in Sintra, Portugal.

“We have seen what happened in the UK and we don’t want the same thing to happen to us,” said a eurozone rate-setter. “It is better to sound a little more hawkish and be prudent about how fast inflation will fall than to be caught out by a negative surprise, which is a problem for a central bank.”

The ECB’s concerns were underlined on Thursday when Germany reported that inflation had risen faster than expected, even as Spain became the first big eurozone economy to see inflation drop below 2 per cent in almost two years.

The divergence between Germany’s 6.8 per cent rate for June, which was more than four times higher than the 1.6 per cent recorded by Spain, highlights the dilemma faced by the ECB over how to tame inflation.

Franziska Palmas, an economist at research group Capital Economics, said: “June’s inflation figures from Germany won’t change the ECB’s hawkish resolve, even if core inflation, excluding energy and food prices, edges down in other countries.”

Eurozone inflation is expected to drop to 5.6 per cent in June when fresh price data is released on Friday — still well above the ECB’s 2 per cent target but down from a peak of 10.6 per cent in October as energy and food prices have continued to fall.

Another ECB governing council member said that if the bank kept raising rates and inflation fell faster than expected, “that could be considered a success”. But if inflation overshot its forecasts and the bank was forced to increase the pace of rate rises — as the BoE did — “we would be accused of failing”.

Inflation in the UK stuck above forecasts at 8.7 per cent in May, significantly higher than the eurozone’s 6.1 per cent or the US rate of 4 per cent, piling pressure on both the BoE and the government. Core prices, excluding energy and food, hit 7.1 per cent, their highest level for 31 years.

An Ipsos opinion poll published this month showed most Britons surveyed thought BoE decisions had contributed to the soaring cost of mortgages — with more pinning the blame on the central bank than on the government, Brexit or Russia’s full-scale invasion of Ukraine.

“The UK situation is something we can learn from,” said a third ECB council member. “We need to project to the general public that we are acting with determination to avoid falling into the same boat as the Bank of England.”

The ECB declined to comment.

The BoE has been beset by communications challenges ever since UK inflation proved more persistent than in the US or eurozone. The BoE was forced by parliament this month to launch a review of its forecasting practices, with officials coming under increasing fire from politicians, the media and the public.

But the ECB has said it will keep raising rates until underlying price pressures are clearly dropping, after raising its forecasts for price growth this month to reflect an expected 14 per cent increase in eurozone wages by 2025, which it thinks may push up prices in the labour-intensive services sector.

Any easing of underlying pressures is unlikely to happen in June, when core eurozone inflation is expected to rise to 5.5 per cent this month, up from 5.3 per cent in May.

Some more dovish ECB council members worry more about the risk of raising rates too high and pushing the economy into an unnecessary recession rather than doing too little.

“Not overreacting is a huge concern for every central bank,” Mário Centeno, the head of Portugal’s central bank, told Portuguese broadcaster RTP on Thursday.

ECB president Christine Lagarde told the Sintra conference that it would raise rates again next month “barring a material change to the outlook” although she refused to be drawn on the chances of a further increase in September, as markets are betting is likely.

The UK’s persistently high price growth forced the BoE to ramp up its rate rises with a half percentage point move to 5 per cent last week, having slowed down to quarter-point moves in March and May.

BoE governor Andrew Bailey told the Sintra conference that UK rates were likely to stay higher than markets expected because, while falling energy prices were likely to bring down the headline rate, the core inflation rate was “much stickier”. 

With the UK’s labour force shrinking since the pandemic hit, Bailey said a “very tight” jobs market and high wage growth could keep price pressures elevated.

Additional reporting by Chris Giles in London