Hints of peaking EU inflation signal ECB rate hike slowdown

The European Central Bank looked on course to slow its campaign of interest rate hikes after fresh data released Tuesday showed inflationary pressures easing a little, as the economy responded to an aggressive tightening of monetary policy over the last year. 

Core inflation in the eurozone, which strips out volatile food and energy components, fell for the first time in 10 months in April, edging down to 5.6 percent from 5.7 percent in March. That bolstered hopes that it has now peaked — even though headline inflation broke a five-month falling streak by ticking back up to 7.0 percent due to strong food and service prices. Both numbers were broadly in line with market expectations.

The strength of core inflation — still over twice the ECB’s medium-term target of 2 percent — makes another interest rate hike at this Thursday’s governing council meeting all but inevitable, but a larger hike seems less likely.

ECB board member Isabel Schnabel told POLITICO in April that she wanted to see a “sustained” slowdown in core prices before changing course. But the slow decline in inflation adds to the arguments that the ECB can afford to take its foot off the brake a little on Thursday.

The dove argument was further strengthened Tuesday by the release of the ECB’s quarterly Bank Lending Survey, which showed that banks have become much more cautious about lending, tightening their credit standards at the fastest pace since the euro sovereign debt crisis a decade ago.

ECB chief economist Philip Lane in mid-April described the Survey, in which banks are asked about the supply and demand of credit, as “the most important” data point in the run-up to the May meeting as it helps to understand “whether we are indeed seeing further tightening of credit conditions.”

With higher interest rates rapidly taking the steam out of housing markets and triggering a string of bank collapses in the U.S. and Switzerland, lenders said they expect to tighten their standards again in the coming quarter. 

Demand for loans had also “decreased strongly” over the quarter, the ECB said. Those factors helped pushed private-sector credit growth to its slowest in nearly a year in March, at 5.2 percent. Growth in the broad M3 money supply, slowed to a nine-year low of 2.5 percent, meanwhile.

“We expect the ECB to use this tightening as justification that (a) their monetary policy decisions are working … and (b) to downshift to rate hikes of only 25 basis points,” analysts at Nomura said in a note to clients ahead of the data.