Most central banks cut rates when the economy is weak. Europe's is about to do the opposite.
Growth across the euro zone is barely there, yet on Thursday the bank is set to raise rates anyway.
The ECB's Case For Raising Rates
The bank has one job, and that is to keep prices in check. Right now they are climbing too fast.
Prices rose 3.2% in April from a year earlier. Energy alone was up almost 11%.
Europe buys a lot of its energy from abroad. So the oil spike from the Iran war hits it hard.
Unlike the Fed, the ECB has just this one target. That makes high prices tough to ignore.
The euro zone imports much of its energy, so a war half a world away shows up in local bills. That is exactly the kind of shock the bank cannot control.
The bank actually held rates back in April. Now the case to move has grown.
To stop the pain from spreading, it is set to lift its key rate by a quarter point to 2.25%. That rate sets what banks earn for parking cash at the ECB, so lifting it makes borrowing across Europe pricier.
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Why The ECB Fears Second-Round Inflation
Here is what is keeping the bank up at night. Core inflation, which leaves out food and energy, rose to 2.5% in April.
The driver was the rising cost of services. That points to what economists call second-round effects.
A one-time shock like pricey oil stops being just an oil problem. It starts pushing up wages and the cost of daily services.
A gas-price jump is a single hit. Second-round effects bake that hit into the whole economy, which is much harder to undo.
Goldman Sachs expects the bank to cut its growth outlook on Thursday and raise its inflation outlook. It notes oil and gas prices are up about 12% since its last forecasts in March.
Société Générale says the 2027 forecast matters most this week. It will show how much the bank trusts that the shock fades.
What To Watch
Markets think this is just the start, with three hikes priced in for this year. The risk is that the bank pushes too hard and tips a weak economy into a full recession.
That is the tightrope here. Raise too little and prices run hot, but raise too much and growth breaks.
Some economists note that activity has softened since the spring, which raises the stakes. Move too fast, and a soft patch could turn into a slump.
One bank says the 2027 outlook will show how worried the ECB really is. As another put it, treating June as a one-and-done hike won't suit the bank.
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