Key facts
- The ECB and BoE are grappling with how to respond to inflation exacerbated by the Iran war.
- Policymakers must balance the risk of acting too late against acting too aggressively and harming fragile growth.
- The ECB is expected to raise interest rates by 25 basis points, while the BoE is anticipated to hold rates steady.
- Eurozone inflation stands at 3.2%, prompting expectations of further ECB rate hikes.
- Some economists argue against further rate hikes, citing existing economic pressures and uncertainty.
- The BoE's decision to hold rates steady is seen as a relative tightening given prior expectations of cuts.
European Central Bank President Christine Lagarde and Bank of England Governor Andrew Bailey are facing a critical juncture as they navigate rising inflation fueled by the Iran war. Both central banks are haunted by past policy missteps, including the slow response to inflation following the Covid pandemic and Russia's invasion of Ukraine, and the ECB's 2011 decision to raise rates into an energy shock.
Economists anticipate the ECB will raise its key interest rate by 25 basis points on Thursday, bringing the deposit rate to 2.75% by year-end, as eurozone inflation stands at 3.2%. However, some economists, like Holger Schmieding, argue that further rate hikes would be a mistake, potentially weakening demand in an already fragile economy facing higher energy costs and uncertainty.
The Bank of England, meanwhile, is expected to hold its benchmark rate steady at 3.75% the following week. This decision, while appearing less aggressive than the ECB's move, represents a relative tightening compared to previous expectations of rate cuts. The BoE is also considering signs of economic weakening, such as rising unemployment. The central bankers must carefully weigh the risks of acting too slowly and allowing inflation to become entrenched against the danger of choking off already fragile economic growth with overly aggressive policy tightening.