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The IMF cautions Europe from claiming victory against inflation too soon

The International Monetary Fund warned against “premature celebration” as inflation declines from its peak and said that the European Central Bank and other policymakers throughout Europe should maintain interest rates at current elevated levels until they are certain that inflation is under control despite slow growth.

According to the Washington-based IMF, there might be severe consequences from underestimating inflation’s persistence, including another painful round of rate rises that would deprive the economy of a significant portion of its growth.

In its biannual regional economic outlook for Europe, the IMF said that the European Central Bank and the other central banks outside of the twenty-nation eurozone “are reaching the peak of their interest rate cycles, while some have started to reduce policy rates.” “That being said, a sustained policy of restraint is still required to guarantee that inflation returns to target.”

According to the IMF, historically, it takes three years on average to bring inflation back to lower levels, and certain anti-inflation efforts have lasted considerably longer. Although the rate-hike cycle seems to have halted, a failure to complete the task and the subsequent resumption to rate rises may cost the economy up to one full percentage point per year.

Speaking to media about the prognosis, Alfred Kammer, the head of the IMF’s Europe section, cautioned against “premature celebration.” According to Kammer, “it is less costly to be too tight than too loose” when it comes to interest rate policy. He said that the ECB “is in a good spot,” having stopped raising interest rates for the first time in more than a year on October 26.

October 2022 saw a high of 10.6% inflation in the eurozone, which has since slowly declined to 2.9% in October.

Between July 2022 and September 2023, the European Central Bank increased its benchmark deposit rate from minus 0.5% to 4%, a complete 4.5 percentage point increase. Since higher rates translate into greater borrowing costs for consumer purchases, funding new officials, and financing industry equipment, central banks often employ higher rates as a weapon to manage inflation. This lowers demand for commodities and lessens pricing pressure, but it also has the potential to harm GDP, giving the ECB a balancing act to manage.

The IMF said that following the effects of the rate rises, Europe was set for “a soft landing” and did not anticipate a recession, but growth projections were still tentative and might go either way.

It projects that the eurozone will increase by 1.2% the next year and by 0.7% this year. Real income for consumers will increase if inflation drops more quickly than anticipated, which might lead to better growth and spending. However, poorer growth may result from an intensification of Russia’s conflict against Ukraine, as well as from heightened sanctions and trade interruptions.

According to Kammer, the month-long conflict between Israel and Hamas in Gaza has temporarily raised energy costs but hasn’t had any negative effects on the European economy.

 

 

 

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