Inflation in the eurozone reached a new high in July, and its peak might be months away, putting pressure on the European Central Bank to hike interest rates again in September.

Consumer price increase in the 19 eurozone nations rose to 8.9 percent in July from 8.6 percent the previous month, significantly above predictions of 8.6 percent and far over the ECB’s 2 percent objective, Eurostat, the EU’s statistics office, said on Friday.

Inflation was first caused by post-pandemic supply constraints, but more recently, the fallout from Russia’s conflict in Ukraine has been the major reason, driving up oil, metals, and food costs.

While rising energy costs continue to be a primary inflationary contributor, processed food and service prices have also increased, indicating that inflation is becoming more widespread.

Fearing that price rise is out of control, the ECB boosted interest rates by 50 basis points this month, deviating from its own forecast for a lower increase, and vowed more rate increases to avoid the start of a difficult-to-break wage-price spiral.

However, the bank is also constrained by inflation. High food and energy prices erode savings and, in the worst-case scenario, hinder growth, even driving the EU into recession.

Indeed, Germany, the eurozone’s largest economy, slowed in the second quarter, setting the stage for a challenging third quarter. Meanwhile, the US economy unexpectedly fell in the second quarter.

Nonetheless, the ECB has made it plain that inflation worries outweigh growth concerns, implying that policymakers are likely to raise rates even if it damages GDP, since inflation is now on the verge of being entrenched.

Indeed, underlying inflation, which excludes volatile food and fuel costs, increased to 5.0 percent from 4.6 percent, more than above the ECB’s objective of 2 percent. Meanwhile, an even narrower measure that excludes alcohol and cigarettes increased to 4.0 percent from 3.7 percent.

The labor market has never been tighter in the eurozone’s two-decade existence, lending credence to concerns for sustained pricing pressures.

The unemployment rate is at a historic low of 6.6 percent, while employment is at an all-time high, implying that wage pressures, a prerequisite for long-term inflation, are already in the works.

Markets are currently pricing in a 35-basis-point rate increase for September, implying that investors are divided between a 25- and a 50-basis-point increase.

They also anticipate a total of 90 basis points of movement by the end of the year, or a hike at each of the three remaining policy sessions.

However, expectations have been reduced in recent weeks as a recession, perhaps caused by the loss of access to Russian gas, is seen compelling the ECB to pursue a more gradual rate path.

The ECB will meet again on September 8.

Source: Reuters


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