Energy Prices Drive May Increase
Euro zone inflation rose to an estimated 3.2% in May, official flash data showed Tuesday, keeping price growth well above the European Central Bank’s 2% target.
The reading matched forecasts in a Reuters poll of economists and is expected to reinforce market expectations for an ECB interest rate hike at next week’s policy meeting.
Energy Remains The Main Pressure Point
Energy costs were the biggest driver of inflation in May, rising 10.9% year over year.
That was slightly higher than the 10.8% annual energy price increase recorded in April, showing that elevated oil and gas prices continue to feed into the euro zone’s inflation outlook.
Services Inflation Also Picks Up
Services inflation rose to 3.5% in May, up from 3% in April.
Food, alcohol and tobacco inflation moved in the opposite direction, easing to 2% from 2.4% the previous month.
Inflation Varies Across The Bloc
Price growth differed sharply between individual euro zone economies.
Germany, the region’s largest economy, saw annual inflation fall to 2.7% in May from 2.9% in April. France recorded an increase from 2.5% to 2.8%, while Greece and Lithuania both posted annual inflation rates above 5%.
Iran War Keeps Energy Costs Elevated
The latest figures show that inflation in Europe is continuing to rise after oil and gas prices increased in the wake of the U.S.-Iran war.
Before the outbreak of the conflict, euro zone inflation had dipped below the ECB’s 2% target. It then rose to 2.6% in March, jumped to 3% in April and reached 3.2% in May.
Europe Remains Exposed To Energy Shocks
The euro zone is especially vulnerable to energy shocks because it is a major net importer of energy.
Higher oil and gas prices can quickly affect transport, industrial costs, household bills and food prices, making energy-driven inflation difficult for policymakers to ignore.
Markets Price In An ECB Hike
Markets are now pricing in a 94% chance that the European Central Bank will raise its key interest rate by 25 basis points at its next meeting, according to LSEG data.
Following the inflation release, the euro was little changed against the dollar at around 1.164 dollars, while the yield on Germany’s 10-year bund fell by 6 basis points.
ING Sees An “Insurance” Hike
Carsten Brzeski, global head of macro at ING, said the May inflation data paves the way for an ECB rate increase next week.
He described the move as a likely “insurance” hike, arguing that the central bank will want to respond to the expected rise in inflation before second-round effects become more entrenched.
Inflation Outlook Points Higher
Brzeski said the energy shock triggered by the Iran war has become more persistent, although oil prices remain below levels feared under more severe scenarios.
He added that inflation in the euro zone is currently moving upward, though not sharply. Instead, the pressure appears moderate and gradual, with energy likely to spill into areas such as transport and food.
ECB Faces A Delicate Balance
The European Central Bank now faces the challenge of responding to renewed inflation pressure without over-tightening policy in a fragile economic environment.
For investors, the May data strengthens the case for a rate hike. The larger question is whether the energy shock proves temporary or becomes a more lasting inflation problem for the euro zone.
