Axios Macro

If the Fed's go-to word is "expeditiously," it's "gradually" for the European Central Bank, which tomorrow is expected to announce its first interest rate increase in over a decade.

• It's one of the last major central banks to pull the trigger, as policymakers everywhere grapple with soaring inflation.

Why it matters: Euro zone inflation is nearly as high as in the U.S., but the underlying drivers are different, as the bloc has been slammed by the economic fallout from Russia's invasion of Ukraine.

• It's complicating the ECB's battle with sharply rising costs while the euro area braces for a recession.

This week alone is riddled with developments that hint at some of the central bank's challenges.

• Italian Prime Minister Mario Draghi said this morning he would stay in power if he wins key confidence votes. His announced intent to resign last week raised fears that the euro zone's third-largest economy would plunge into political instability at a delicate time.
• The potential departure of the former ECB president and much-respected figure could complicate the central bank's internal politics over how to deal with widening gaps between what Italy and other countries must pay to borrow money.

Meanwhile, today Russia signaled it could keep natural gas flowing to Europe following a critical pipeline's maintenance shutdown, but volumes will be curtailed.

• Euro zone officials are on edge about gas supply. They are looking for ways to curb consumption while they hunt for alternatives. But interest rate policy can't really do anything to help on that front.

The intrigue: Those risks are among the reasons why market-watchers are already mulling when the ECB will pause raising rates — even before they make their first move.

• "You have to sound very tough in the face of this eye-watering inflation, but at some point, the focus will shift," BlackRock Investment Institute's Wei Li, who expects rates to peak at 0.75%, tells Axios.
• "We believe European policymakers will blink because any recession could be traumatic, especially amplified by an energy crisis."

What to watch: Until this week, the ECB looked likely to hike interest rates a quarter-point. Then, multiple news outlets reported officials were mulling a larger, half-percentage point move.

• A smaller move would keep key interest rates negative, while a bigger one would take them exactly to zero.
• The deposit rate has been negative since 2014, forcing banks to pay up to park money at the central bank — a mechanism meant to encourage them to lend.

What they're saying: "The economy can withstand the removal of these extraordinary measures, but the window for doing so is perhaps narrowing with the energy crisis looking like it's becoming more acute by the day," possibly pushing policymakers to act more aggressively now, PGIM Fixed Income's chief European economist Katharine Neiss tells Axios.

The temperature isn't the only thing scorching Britain. New data out this morning showed consumer prices have risen 9.4% over the last year, a new four-decade high.

• Relief is nowhere in sight. The Bank of England expects inflation to peak at 11% this year before receding.

State of play: The U.K. has a worst-of-all-worlds inflation problem. It's experiencing the same energy price spikes seen around the world — oil is a globally traded commodity, after all. But there's more.

• In contrast to the United States, where a surging dollar has diminished inflation pressure from imports, the pound has fallen 11% against the dollar this year (it was a bit under $1.20 this morning), and has retreated against the euro since the spring.
• Additionally, the country is dealing with unique supply chain problems post-Brexit, which is complicating many longstanding trade arrangements.

The BoE's monetary policy committee meets in two weeks and has signaled it may be ready to join the global trend of aggressive interest rate increases. The bank's governor Andrew Bailey said this week that a half-percentage-point rise is on the table.

The bottom line: Factors unique to the British economy may make taming inflation there even harder than it is in America.