Key Takeaways
- Energy prices drove eurozone inflation higher in August, while core inflation was slightly down from July.
- Financial markets are signaling that a 0.25 percentage point ECB rate hike on Sept. 10 is almost certain.
- Eurozone inflation is expected to remain above 3% for the rest of the year and could peak at around 3.5%, before falling back toward 2% in 2027.
Rising energy prices drove eurozone consumer prices up by 3.3% year over year in August, from 2.9% in July, according to Eurostat’s flash estimate. This uplift in inflation means the European Central Bank is almost certain to raise its key interest rate by 0.25 percentage points next week.
Core inflation, which excludes volatile components such as energy and food, came in at 2.4% in August, down from 2.5% in July.
While overall inflation was in line with FactSet consensus estimates, core inflation was lower than expected. Eurozone inflation remains well above the European Central Bank’s medium-term inflation target of 2%.
According to Eurostat’s estimates, annual energy inflation came in at 14.3%, up from 10.3% in July. Services rose by 3.0%, compared with July’s reading of 3.3%. Food, alcohol, and tobacco prices increased by 1.2%, unchanged from July’s reading, and nonenergy industrial goods prices were up 1.2% year over year, compared with 0.9% in July.
The numbers came against a backdrop of falling equities and turmoil in global bond markets, as rising oil prices and inflation concerns pushed government bond yields higher.
Will the ECB Raise Interest Rates Next Week?
“With European inflation sitting firmly above the ECB’s targeted level, expectations are increasing for interest rate increases,” says Michael Field, Morningstar’s chief European markets strategist. “Polling of economists is pointing to an almost nailed-on 25 basis point increase at the next meeting to 2.5%.”
Before the inflation data were released, swap markets, where investors trade expectations for future interest rates, were pricing in a roughly 96% probability of a 0.25 percentage point rate hike in September. Another increase of the same size was priced in for the spring.
Expectations for a September move were further reinforced by comments from ECB executive board member Isabel Schnabel. “At the current policy rate, inflation is unlikely to return to target over the medium term, and therefore further tightening will be necessary,” Schnabel told Bloomberg on Aug. 26.
“Even if the ECB doesn’t like the term, the second rate hike this year would also fall into the category of insurance rate hike,” says Carsten Brzeski, global head of macro at ING. This would be a rate hike to strengthen the ECB’s credibility and to pre-empt any possible indirect or even second-round effects from the current energy price shock, he adds. Second-round effects emerge when higher prices feed into wages and subsequently trigger further price increases.
“With inflation still accelerating, the ECB is all but certain to hike at next week’s meeting, in line with our expectations. However, unlike markets, we think it is too early to pencil in a third hike, especially given that underlying price pressures remain contained for now,” says Leo Barincou, senior economist at Oxford Economics.
The ECB began a cycle of rate hikes in July 2022, raising the deposit rate from -0.50% to 4.00% through 10 consecutive increases. From September 2023, it then cut interest rates eight times, bringing the benchmark rate back to 2.00%, before policymakers resumed raising rates in June 2026.
Iran War Keeps Energy Inflation Elevated
Brent crude oil rose by 2.5% to above USD 90 per barrel in the course of the month as hostilities in the Middle East intensified at the end of August. The natural gas market however is of more concern, according to analysts, with European benchmark TTF natural gas prices up 22% since the end of July.
The US and Iran exchanged strikes in late August for the first time in about a month, with American forces hitting Larak Island in the Strait of Hormuz and Iran retaliating with attacks targeting the United Arab Emirates and Jordan.
“Looking ahead, the path of headline inflation remains highly affected by the war in the Middle East and oil prices,” says ING’s Brzeski. “In our new base case scenario, we are assuming that the war will continue and relief will only come after the US midterm elections. Against this background, oil prices would stay higher for longer, pushing up headline inflation to above 3% and keeping it there at least until year-end.”
Persistently low gas storage levels are expected to drive up wholesale gas prices in the coming weeks, likely resulting in higher retail energy costs early next year, Brzeski adds. Combined with higher transportation expenses and drought-driven increases in food and industrial product prices, these pressures could delay the return of overall inflation below 2% until the end of 2027, he says.
“With Qatar LNG exports severely constrained and Europe facing fierce competition from Asian buyers for US LNG, we forecast EU gas storage at an all-time low of 69% by Nov. 1, equating to 37% of the gas consumption of a normal winter, the lowest level since the 2021-22 energy crisis,” says Morningstar analyst Tancrede Fulop.
A Mixed Inflation Picture Across the Eurozone
Inflation varied across the bloc, with annual rates ranging from 1.3% in Estonia to 5.8% in Lithuania.
Italy’s annual inflation came in at 3.2% in August, compared with 2.9% in July. Germany’s inflation rate came in at 2.9%, up from 2.8% in July, France’s inflation rate stood at 2.7% from 2.4% in July, and Spain’s year over year number came in at 4.5%, an increase from 3.9% in July.
