The International Monetary Fund (IMF) has warned that the European Central Bank (ECB) and other policymakers in Europe should maintain current elevated interest rates until they are certain that inflation is under control. In its twice-yearly regional economic outlook for Europe, the IMF emphasized the importance of avoiding a premature celebration as inflation declines from its peak. The IMF highlighted that underestimating inflation’s persistence could result in another round of painful rate hikes, potentially hampering economic growth.
The IMF acknowledged that central banks, including the ECB and the Bank of England, have reached the peak of their interest rate cycles and some have already begun reducing policy rates. However, the IMF stressed that a prolonged restrictive stance is still necessary to ensure inflation returns to target levels. The organization noted that historically, it takes an average of three years to lower inflation, with some anti-inflation campaigns lasting even longer. Failing to complete the job of controlling inflation could result in a loss of up to one percentage point of annual economic output.
Alfred Kammer, director of the IMF’s Europe department, cautioned against premature celebration during a press briefing. Kammer stated that it is less costly to be too tight with interest-rate policy than too loose. He commended the ECB, which halted its rate increases in October 2023 after over a year of consecutive increases, indicating that the ECB is currently in a good position.
The IMF highlighted that inflation in the eurozone peaked at 10.6% in October 2022 but has since fallen steadily to 2.9% in October. The European Central Bank raised its benchmark deposit rate by 4.5 percentage points between July 2022 and September 2023, from minus 0.5% to 4%. Higher interest rates are typically employed by central banks to control inflation, as they increase borrowing costs for consumer purchases and business investments, reducing demand for goods and alleviating price pressures. However, higher rates can also negatively impact economic growth, presenting a challenging balancing act for central banks like the ECB.
In contrast to the ECB, the Bank of England maintained its benchmark rate at 5.25% during its recent policy meeting last week.
Although the IMF expressed confidence in a “soft landing” for Europe following the impact of rate hikes, it cautioned that growth forecasts remain uncertain and could turn out better or worse than expected. The IMF projected a growth rate of 1.3% for the region, including the UK and Switzerland, this year, with a slight improvement to 1.5% next year. For the eurozone, the forecast is for 0.7% growth this year and 1.2% next year. The IMF noted that if inflation declines more rapidly than anticipated, it could boost consumer income, spending, and overall growth. However, the ongoing conflict between Russia and Ukraine, along with potential increased sanctions and trade disruptions, could lead to weaker growth.
Regarding recent geopolitical events, the IMF clarified that the monthlong war between Israel and Hamas in Gaza has temporarily driven up oil prices but has not yet had a significant impact on the European economy.
Overall, the IMF’s regional economic outlook for Europe emphasizes the need for caution and continued vigilance in managing inflation and interest rates to ensure long-term economic stability while avoiding any potential setbacks to growth.
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