The president of the European Central Bank has suggested companies are taking advantage of high inflation when increasing prices, after the bank raised interest rates by a quarter of a percentage point to tackle the cost of living surge.
Christine Lagarde said wage pressures in the eurozone had strengthened, as workers try to recoup some of the purchasing power they have lost due to inflation, but she hinted some firms were engaging in so-called greedflation.
She said: “In some sectors, firms have been able to increase their profit margins on the back of mismatches between supply and demand, and the uncertainty created by high and volatile inflation.”
The interest rate rise marked the seventh successive increase in borrowing costs in the single currency bloc, and came after the US Federal Reserve raised rates to the highest level in 16 years on Wednesday despite concerns about the worst banking crisis since 2008.
The latest increase pushes the ECB’s deposit rate up to 3.25%. The refinancing rate rose by a quarter of a percentage point, to 3.75%. The central bank, responsible for managing inflation across the 19-member bloc, has steadily increased its deposit rate from -0.5% last summer.
However, the increase marks a slowdown from rises of half a percentage point used by the ECB in previous months, raising the prospect of the central bank entering the final stage of its most aggressive assault on inflation since the start of monetary union in 1999.
“While today’s hike is the seventh increase in a row, it is the smallest in the current cycle, suggesting that the ECB has entered the final stage of this tightening cycle,” said Carsten Brzeski, the global head of macro at the Dutch bank ING.
Financial markets had widely expected a rise after eurozone inflation increased for the first time in six months, to 7% in the year to April. Despite a drop in core inflation – which excludes volatile items such as energy and food, and is closely watched by rate setters – from a eurozone record of 5.7% in March to 5.6%, the central bank warned underlying inflationary pressures remained strong.
Lagarde suggested the job on bringing down inflation was not yet done. “The inflation outlook is too high and has been so for too long,” she said.
The ECB stood ready to raise interest rates further to ensure that inflation returns to its 2% target over the medium term, she said, although it would also monitor closely the strength of the economy and impact of past rate increases. “We are not pausing. That’s very clear … We know we have more ground to cover.”
Central banks around the world have responded to soaring inflation after the Covid pandemic and Russia’s invasion of Ukraine with the most aggressive round of interest rate rises in decades. However, the latest round of increases comes despite concerns over the fallout from the worst turbulence in the banking sector for years.
Three US banks have failed in the space of two months, with the California-based lender First Republic the latest to collapse on Monday. Regulators brokered a deal for JP Morgan to buy most of the bank’s assets and deposits.
Lagarde said renewed financial market tensions, if persistent, would “pose a downside risk to the outlook for growth,” because they could further tighten the availability of credit to businesses and households.
Economists and investors expect the Bank of England to follow suit when its policymakers meet on Thursday next week, with predictions of a quarter-point rise from the current level of 4.25%. Threadneedle Street has raised rates 11 times in a row since December 2021, while Britain faces the highest inflation in the G7.
