Key Takeaways
- Eurozone inflation is expected to remain unchanged in July, while core inflation is likely to edge higher.
- Economists see little evidence of second-round effects from high energy inflation, as wage and services dynamics remain contained.
- The European Central Bank is expected to raise rates by 0.25 percentage points in September.
Preliminary data due on July 31 is expected to show that eurozone consumer prices were 2.8% higher than a year earlier, according to FactSet consensus estimates. That is unchanged from June’s final inflation reading of 2.8%, and above the European Central Bank’s medium-term inflation target of 2%.
Core inflation, which excludes volatile components such as energy and food costs, is expected to have risen by 2.5% year over year in July, up from 2.4% in June.
“The modest rise in core inflation is certainly not the end of the world, and investors will likely shrug it off,” says Michael Field, Morningstar’s chief European markets strategist. “But, at the same time, it’s a move in the wrong direction.”
Some economists even see inflation easing. Deka’s chief economist Ulrich Kater expects headline inflation to edge down slightly to 2.7%, citing favorable base effects—comparisons with last year—in both energy and food prices, while forecasting core inflation to remain unchanged at 2.4%. He expects stronger industrial goods inflation to offset slightly weaker services inflation.
“The outlook for inflation in the euro area is caught between opposing forces,” Goldman Sachs analysts say. “On the one hand, the incoming inflation data has been weaker in Europe and globally, and price surveys have started to cool. On the other hand, the resumption of military conflict in the Middle East and Russian refinery outages have driven sharp increases in the prices of crude oil, oil products, and natural gas.”
No Evidence of Second-Round Effects Yet
Higher energy prices typically feed through gradually to production costs, broader inflation, and, ultimately, wage growth through second-round effects. These effects occur when businesses pass higher costs on to consumers, who in turn demand higher wages to compensate for rising prices. For now, economists see little evidence that this cycle has begun.
Goldman Sachs says the direct effects of the energy shock were initially very strong in March, while indirect effects built up by April before fading by June. “There were no convincing signs of second-round effects throughout,” the analysts say.
Deutsche Bank Research says the ECB has become increasingly concerned that the energy shock could spread to other parts of the economy, but recent inflation data suggests this process has so far remained limited. Services inflation eased in June, while underlying measures of inflation also softened, weakening the case that broader price pressures are taking hold, the analysts say.
What Is the Inflation Outlook for 2026?
Most economists expect inflation to remain above the ECB’s 2% target through much of 2026 before gradually easing as energy-related price pressures fade, with the path largely depending on how strongly higher energy costs feed through to consumers and wages.
Energy prices remain the key uncertainty, with near-term inflation dynamics highly sensitive to oil and gas price trajectories. Renewed tensions in the Middle East briefly pushed Brent crude above USD 100 a barrel and sent European natural gas prices to their highest levels since March, although prices have since retreated on hopes of renewed diplomatic talks.
AllianceBernstein economist Sandra Rhouma expects inflation to move back above 3% in the coming months as higher oil and gas prices filter through to consumers. Yet she says that wage growth continues to slow and that second-round effects remain absent, limiting the need for a prolonged tightening cycle. “A September rate hike would be less a response to inflation already spiraling out of control than a preventive step to stop second-round effects from emerging,” she says.
Deutsche Bank Research analysts also say risks to the inflation outlook are “clearly skewed to the upside” because of higher oil and gas prices, though they see little evidence that the energy shock has broadened into the wider economy. June services inflation eased, core goods inflation softened, and broader measures of underlying inflation have continued to moderate, suggesting that the feared pass-through has so far remained limited.
Will the ECB Raise Interest Rates in September?
Activity in derivatives markets already implies another quarter-point increase as the most likely outcome after the central bank left interest rates unchanged in July.
“This week’s inflation data could go a long way towards sealing the deal for a hike,” says Enrique Díaz-Alvarez, chief economist at Ebury. He says that stronger economic data, higher energy prices, and President Christine Lagarde’s firmer communication have already led markets to price in roughly an 80% probability of a September increase.
ING chief economist Carsten Brzeski says that Lagarde struck a distinctly more restrictive tone at the July meeting, highlighting upside risks to inflation while stressing that “there were no second-round effects from higher headline inflation, yet.” In his view, “the question is what could stop the ECB from hiking in September, rather than what would move the ECB to hike.”
But not everyone is convinced that another increase is inevitable.
Berenberg chief economist Felix Schmidt argues that the next decision will largely depend on developments in energy markets over the coming weeks. If oil prices retreat, the ECB could leave rates unchanged in September. “The burden of proof is on the data,” he says, with two additional inflation reports, second-quarter GDP figures, and updated ECB staff projections available to policymakers before making their decision.
Morningstar’s Michael Field expects the ECB to remain focused on incoming inflation data and, in particular, on whether higher energy prices begin feeding into wages and broader consumer prices. As long as second-round effects remain limited, policymakers are unlikely to embark on an aggressive hiking cycle even if another increase in September becomes the central scenario.
“Despite inflation sitting far above the European Central Bank’s targeted level, up to now markets have been largely unconcerned. The fact that the banks themselves have not rushed to raise interest rates has helped, as has the belief that the Iran war would likely come to a swift end, with the Strait of Hormuz quickly reopening,” he adds.
But as the conflict drags on and the second-round effects of inflation start to work their way through the system, investors may have to revise their expectations for interest rates and economic growth, he says. “That may in time prove to be a drag on markets.”
