Inflation across the 20 countries that use the single currency remained stable in August at 5.3%, but far away from the 2% target of the European Central Bank. Policymakers are now contemplating a pause in rate hikes, given a deterioration of the economic growth outlook and the risk of a recession.
While eurozone inflation showing signs of abating, dropping to 5.3% in July, it remains well above the ECB medium-term target of 2%. Core inflation - without energy and food prices which are considered more volatile, - it also remains stubbornly high at 5.5%.
Higher interest rates have also started to affect the European economy, as intended by the ECB’s policymakers. Construction, which is traditionally sensitive to interest rates, is feeling the pain. Stingier bank lending is leading to a 0.4 percentage-point reduction in GDP growth each quarter, according to Goldman Sachs, a bank. Corporate insolvencies rose by more than 8% in the year’s second quarter, compared with the first, and have reached their highest since 2015. The impact of tighter monetary policy will peak in the second half of this year, predicts Oliver Rakau of Oxford Economics, a consultancy.
The August Purchasing Managers’ Index (PMI), published this week, placed the bloc’s business activity at its lowest level since 2020, driven by a sharp contraction in the services sector and a continued decline in manufacturing. Economic powerhouse Germany is the worst hit. This poses a dilemma for the ECB, which is expected to make its next move on interest rates in September.
The central bank has been raising the borrowing rate in a bid to curb rising inflation and tame consumer prices. In July, its ninth consecutive rise of 25 basis points took the deposit rate to 3.75%, a joint record high last seen in 2000.
As eurozone businesses face sharp declines in outputs and new orders, experts believe the European Central Bank (ECB) faces a complex challenge as it decides whether to continue its cycle of interest rate hikes in September. ECB chief Christine Lagarde has repeatedly said interest rates will continue to rise until pressures on consumer prices decline but economic experts believe the negative PMI outlook and other signs of stunting economic growth may split opinions on the Governing Council, the main decision-making body of the ECB.
"The ECB will be more concerned with the current rates of inflation as opposed to the decline in business activity, which was not at all unexpected," Stefan Gerlach, Research Fellow at the Centre for Economic Policy Research (CEPR) and Chief Economist at EFG Bank, told Euronews. "I suspect some members of the Governing Council will want to remain cautious by raising interest rates further, whilst others will want to pause hikes to ease pressure on the economy."