Europe's central bank weighs jumbo rate hike after Fed slows

The European Central Bank is deciding how big to go with its interest rate hike

The European Central Bank faces a close call Thursday between slowing its rapid pace of interest rate increases — much like the U.S. Federal Reserve — or pressing ahead with another jumbo hike to try to squelch inflation that has sent costs spiraling in grocery store aisles.

After six straight increases of either half- or three-quarters of a point, ECB President Christine Lagarde and the rest of the governing council could downshift to a more typical quarter-point increase, analysts say.

But with inflation in the 20 countries that use the euro currency well above the bank's target of 2%, the ECB may well opt for the larger increase even as economic growth slows to a crawl and U.S. bank instability stirs new fears of financial turmoil.

The ECB meeting comes a day after the Fed raised rates by a quarter-point and hinted that it may pause its streak of hikes, which has heightened the threat of recession. The ECB started raising rates later than the Fed, and economists predict it may have further to go before reaching a level that would definitively corral inflation.

Higher rates make it more expensive for people and businesses to borrow — from bank loans to mortgages — reducing demand for goods. That eases pressure on prices but potentially weighs on economic growth.

Consumer prices in the eurozone jumped 7% in April from a year earlier, down from a peak of 10.6% in October but up slightly from March.

Inflation has been fueled by Russia’s invasion of Ukraine, which drove up oil prices and led Moscow to cut off most natural gas to Europe. Energy costs have since fallen, but the surge is still feeding through to higher prices for goods, services and food.

The spiking cost for Europeans to feed their families has become the new pain point. Food prices jumped 13.6% in April from a year earlier, following a 15.5% annual increase the month before.

The central bank also is concerned about so-called core inflation, which excludes volatile fuel and food prices. It's considered a clearer picture of whether price pressures are building up in the economy from demand for goods and higher wages.

Core inflation fell only slightly in April, to 5.6% from a record 5.7% in March. Workers across Europe have been striking for wages that keep pace with inflation, with analysts saying average pay rises could hit 5% this year — driven by eye-catching deals like German public employees' 11% salary increase over two years.

That argues in favor of a larger hike. So does the fact that renewed turmoil in the U.S. banking system appears — so far — not to be shaking the stability of Europe's banks, the chief source of credit for businesses.

U.S. officials seized First Republic Bank this week and sold it to JPMorgan Chase, the third major bank failure following the collapse of Silicon Valley Bank and Signature Bank in March.

The earlier turmoil enveloped long-troubled Swiss lender Credit Suisse and led to a government-orchestrated takeover by rival UBS, but European financial officials say their banks have minimal direct exposure to the U.S. troubles.

Nonetheless, the most recent ECB survey of bank lending shows financial institutions growing stricter about lending as well as companies and homebuyers applying for fewer loans — a sign that higher interest rates are taking effect.

The ECB meeting could result in a compromise. A half-point could prevail, with the trade-off being a delay in further moves depending on how the economy is doing. If the decision is a quarter-point, that could come with a warning that several further moves are likely.

Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said a quarter-point was more likely.

Recent data are “consistent with the view that the ECB’s tighter monetary stance is being transmitted to the real economy, reducing the risks to the inflation outlook,” he wrote in a research email.

“Even more importantly,” he added, public comments from bank officials “have shifted to a more pragmatic stance, insisting on the need to proceed more cautiously from here.”

The central bank has pressed ahead with rate hikes despite concerns about their impact on economic growth. The eurozone barely scraped out 0.1% growth in the first three months of the year compared with the previous quarter.

Depending on Thursday's decision, the ECB's benchmark rate on deposits from banks could go from 3% to 3.25% or 3.5%.