Beating inflation: How do Europe and the US compare?

The US Federal Reserve's announcement on Wednesday (May 1) that it would not be cutting interest rates any time soon was not a surprise.

For the past few months, inflation has crept back up steadily, causing significant headaches for policymakers, central bankers and investors who had been expecting not one but several interest rate cuts over the course of 2024.

The picture is not hugely different in Europe. Germany's inflation rate rose more than expected in April, on the back of strong food and energy prices. That has also reduced expectations that the European Central Bank (ECB) will make several rates cuts this year, as some had anticipated.

This recent data is "not really settling the issue of 'the last mile,'" Francesco Papadia, a senior fellow with the think tank Bruegel and a former director general for market operations at the ECB, told DW. "The news is not bad, but not as good as one may wish."

That last mile he refers to is getting inflation down to a consistent rate of 2%, a goal which has been shared by European and US central bankers since they began tackling the global surge in inflation which began in 2021 and peaked towards the end of 2022.

It leaves the US Fed in a particularly tricky position. "For the Fed, the threshold to raise rates is still greater than the threshold to cut," Diane Swonk, chief economist at consultancy KPMG US, told DW. "But they're starting to both get pretty high."

Inflation returns with a bang

From 2021-23, inflation rates around the world hit their highest levels in decades as the global economy adjusted to various shocks, from the COVID-19 pandemic to the war in Ukraine. Central banks responded with aggressive interest rate hikes.

US interest rates are currently at a 23-year high of 5.25% to 5.5% while in the eurozone, the ECB is currently holding rates at record highs of between 4% and 4.75%.

"Interest rates are the main tool for the central bank to influence the economy," said Papadia. "The mechanism is simple — if you raise interest rates, investments go down because the cost of funding those investments go up. If you increase interest rates, you affect consumption, as people are then more likely to delay spending."

For central banks devoted to economic stability, "interest rate changes are the most important tool," he added.

That helps explain why the Fed and the ECB are both so cautious at present regarding possible interest rate cuts. In late 2023 and early 2024, inflation rates were edging closer and closer to the stated 2% goal and it appeared inevitable that the aggressive interest-rate policy could be quickly rolled back.

However, with inflation creeping back up, there are fears that rate cuts now could make the problem worse and push inflation even higher.

"It is likely to take longer for us to gain confidence that we are on a sustainable path down to 2% inflation," Fed chair Jerome Powell said during his announcement on Wednesday. "I don't know how long it will take."

It leaves US policymakers in a somewhat awkward holding position, according to Swonk. "They're stuck waiting, and that frustrates financial markets," she said. However, she believes they are extremely wary of cutting too early as evidenced towards the end of 2023, when they did not cut despite falling inflation rates.

"The one thing the Fed has not done is to prematurely cut. It knows that is the biggest cardinal sin," she said. "They will not prematurely cut. They've been down this path before."

European vs. US inflation

In Europe, inflation appeared to be under reasonable control until April inflation data for Germany and Spain were released showing increases of 0.5% and 0.7% respectively compared with March. However, ECB policymakers have strongly suggested they will cut rates for the first time in five years at their June meeting, with eurozone core inflation on the whole slowing to 2.7% in the first quarter of 2024.

In the UK, outside of the EU but still part of the overall European economy, interest rate cuts are also expected soon.

"I wouldn't go as far to say that inflation has been tamed, but the outlook is certainly less concerning than it was in the middle of last year," Andrew Goodwin, chief UK economist with Oxford Economics, told DW. "We expect the Bank of England to begin cutting interest rates in the summer."

While the European and US inflation situations mirror each other to a certain extent, a key difference according to experts is that European inflation has been largely influenced by energy prices, whereas in the US, surging demand backed by a booming economy has pushed prices back up.

"The situation is different in the United States, and the European economy is just not showing the same degree of buoyancy as the American one," said Papadia.

Swonk agrees and says a key part of the overall story is what she calls the "remarkable resilience" of the US economy, which saw the "fastest deceleration in inflation in nearly 50 years and the longest span of low unemployment figures since the 1960s."

"To think that with all the rate hikes we had, the economy accelerated? That's remarkable resilience and that's good. The hard part is it also came with some heat."

Interest rate hikes?

Now, the big question in the US is whether or not interest rates will actually be increased rather than cut, a situation that seemed unthinkable just a few months ago.

Powell suggested this week that would not be the case, but the stubbornly high inflation seen in recent months continues to cast some doubts.

"It's probably not as bad as it looks, but we won't know until we get into the summer or into the late spring how much this is going to stick or not," said Swonk.

Edited by: Uwe Hessler