Eurozone: Inflation hits record as ECB considers how fast it raises interest rates

Eurozone inflation, which is part of this week’s key data feed, hit an all-time high, intensifying the debate at the European Central Bank over how quickly to raise interest rates from record lows. Consumer prices rose 8.1% year-on-year in May, exceeding the market’s median forecast of 7.8%. The acceleration was driven by food and energy after Russia’s invasion of Ukraine boosted commodity prices. The core inflation indicator, which excludes volatile items such as these, rose by 3.8%.

While the weak economic mood intensifies with the negative contribution of geopolitical risks, high energy costs increase the inflationary pressure and strengthen the determination of the European Central Bank to raise interest rates in this environment. Russia’s attack on Ukraine and the extra steps it has taken against sanctions remain the biggest risk to the eurozone economy. Production slowed due to rising input prices and renewed supply chain bottlenecks. Meanwhile, the EU’s ban on Russian oil risks further putting pressure on rising prices, in part as the war has disrupted wheat and fertilizer supplies.

If we look at the sub-items; Although the increase in headline inflation is mainly due to energy and commodity prices, when we look at the details, it is seen that the upward trend in prices is reflected in general. European governments have implemented a number of measures to ease the burden on households. Still, prices saw record increases this month in France, Italy and Spain. The energy price shock hit some countries harder than others. The German CPI figure, which is also an important indicator of Euro Zone data, rose from 7.4% to 7.9% yesterday. France imposed price ceilings on gas and electricity prices, which eased the blow to households.

Core inflation rose from 3.5% to 3.8%, despite the easing of seasonal effects on travel services due to the timing of the Easter holiday. Food and alcohol inflation rose from 5% in March to 6.3% in April and rose to 7.5% in May as the war in Ukraine pushed up prices for agricultural commodities. The data shows that road fuel costs rose again in May after government intervention helped lower pump prices the previous month, confirming what European Commission data showed earlier.

Eurozone headline and core CPI comparison… Source: Bloomberg, Eurostat

From the perspective of the ECB; Price pressures are mounting in the euro area, prompting the ECB to set a roadmap to withdraw stimulus from July. With rate hikes in full swing in the US and UK, the ECB is poised to raise borrowing costs for the first time in more than a decade to combat the unprecedented price rise. Even if there is no clear action or action at the meeting on June 9, the planning will be revealed. If the Fed is put on hold in September, different dynamics will of course be discussed, but the structure of inflation is different in the two economies. The Fed has room to intervene directly in demand inflation with rate hikes, but for the ECB, the price imbalance that will occur with the oil embargo will weigh external factors too much, thereby fueling the effects of double-sided inflation-recession.

The camp advocating interest rate hikes has gained strength. Lagarde stated last week that quarter-point increases are likely at the meetings to be held in July and September. Chief economist Lane also supported this timeline, saying at the meetings to be held in July and September, a 25 basis point increase would lead to a normalization in monetary policy. Some officials, for the first time in the history of the ECB, also referred to the latest Fed decision, bringing up half-point increases. Therefore, the possibility that the ECB will gain momentum in tightening cannot be overlooked. Money markets are pricing in a 115 basis point tightening on ECB rate hike bets through December.

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