Persistent Inflationary Pressures May Provide Basis for ECB Interest Rate Hikes

■ European Central Bank (ECB) President Christine Lagarde and Executive Board member Ryan pointed out that the Eurozone economy is performing robustly, but inflationary pressures persist.  

■ Uncertainty surrounding the Middle East situation continues, and persistent concerns about inflation may become a reason for the ECB to raise interest rates.  
 
From June 22nd to 23rd, ECB President Lagarde and ECB Chief Economist and Executive Board member Ryan addressed the European Parliament. Although neither explicitly stated what specific policy measures would be taken in the future, both emphasized the resilience of the Eurozone economy and the persistently strong inflationary pressures. 

 
The preliminary Eurozone PMI for May, released on the 23rd, also confirmed the above views of ECB officials. The composite PMI index was 49.5, up 0.9 percentage points from the previous month and higher than market expectations. Although the index has been below the 50-point threshold for three consecutive months, the final revised value may still be revised upwards because a large number of survey responses were collected before the US-Iran agreement was reached in mid-June. The services PMI was 48.9, up 1.2 percentage points from the previous month, but still relatively weak. The manufacturing PMI, however, was 51.3, down 0.3 percentage points from the previous month, but has remained above 50 for five consecutive months, demonstrating strong resilience. In terms of sub-indices, employment and new orders both improved. Regarding price-related indicators, both input and output price indices declined significantly due to falling energy prices, but remained above pre-conflict levels, indicating continued inflationary pressure. 
 
In the May Eurozone Consumer Price Index (HICP revised figure), not only did the overall index rise by 3.2% year-on-year, but the core index excluding energy, food, alcohol, and tobacco rose by 2.6% year-on-year and also saw faster growth. In particular, the sharp rise in service prices (up 3.5% year-on-year) meant that Eurozone inflation was already showing a strong trend above the 2% target level before the full effects of the second wave of inflation became apparent. The resilience of economic activity, as reflected in the PMI survey, may further encourage companies to pass costs on to end-user prices; therefore, the European Central Bank's vigilance regarding inflation is expected to remain. 
 
Even after the US and Iran reached an agreement, uncertainty in the Middle East remains, and concerns about inflation will continue to provide justification for further interest rate hikes by the European Central Bank. In a speech in March this year, President Lagarde proposed three scenarios for monetary policy responses to the current energy shock: (1) keeping interest rates unchanged – when the shock is only a short-term phenomenon; (2) gradual interest rate hikes – when the shock lasts for a limited time but causes inflation to deviate significantly from the target; (3) sharp interest rate hikes – when inflation deviates significantly from the target and lasts for a long time. In her speech on the 22nd, although she denied the possibility of the third scenario, she also pointed out that since the wage formation mechanism may become more sensitive to new shocks, we should not be complacent and express vigilance regarding the transmission of wage increases to the prices of services linked to it. In addition, Executive Board member Lane stated that the Eurozone is facing the risk of "inflation rates remaining above the target level for a long period of time." In her speech on the 18th, she also noted that, since the upper limit of the neutral interest rate range may already have risen, further interest rate hikes are warranted. Considering the above factors, the European Central Bank is expected to take further policy action between July and September to address persistent inflationary pressures.