Key Takeaways:
Germany's inflation rate jumped to 2.8% in July from 2.4% in June, the highest in three months, as the expiration of fuel tax relief and elevated oil prices pushed energy costs up 8.3% year-on-year.
"Renewed disruption of energy supplies could increase energy prices further and for longer than expected," ECB President Christine Lagarde said at the July 23 press conference, warning that sustained energy cost increases risk feeding into broader inflation through indirect and second-round effects.
Spain's inflation also accelerated, reaching 3.8% in July, above economists' forecasts. The two reports precede Friday's release of French, Italian, and aggregate eurozone data, which economists expect to show headline inflation holding at 2.8% or edging up to 2.9%. The euro traded near $1.08 while German 10-year bund yields rose 4 basis points to 2.45% on the data.
The ECB held its main rate at 2.25% in July after delivering a quarter-point increase in June — its first hike since 2023. Derivatives markets now price roughly an 80% probability of another 25-basis-point increase at the Sept. 24 meeting, according to CNBC. The question for policymakers is whether higher energy costs will prove transitory or embed themselves in wage demands and services prices.
Slovakia's central bank chief Peter Kazimir said the ECB needs at least one more rate increase even if Middle East tensions ease, to prevent inflation expectations from becoming de-anchored. Lithuania's Gediminas Simkus said the likelihood of a hike is "far higher" than holding steady. Their comments align with Lagarde's warning that the ECB now expects inflation to remain "well above target" through the first half of 2027.
Germany's energy price index rose 8.3% year-on-year in July, the fastest pace since April, after the government allowed fuel tax relief to expire. The increase compounds upward pressure from Brent crude, which traded above $98 a barrel this week after briefly topping $100 on renewed U.S.-Iran hostilities. European natural gas prices also climbed to their highest since March.
The transmission of energy costs to core inflation remains the key uncertainty. Eurozone core inflation eased to 2.4% in June from 2.5%, and economists at Goldman Sachs said they found "no convincing signs of second-round effects" in the data so far. Services inflation moderated, and broader underlying measures softened, weakening the case that price pressures are broadening.
Traders are betting the ECB will follow through on its hawkish signals. Overnight-indexed swaps imply a quarter-point increase in September, with the probability rising after the German and Spanish prints. ING chief economist Carsten Brzeski said Lagarde struck a "distinctly more restrictive tone" at the July meeting, adding that "the question is what could stop the ECB from hiking in September, rather than what would move the ECB to hike."
Germany's economy grew faster than expected in the second quarter, with first-quarter data also revised higher, giving the ECB additional room to tighten without triggering a recession. The resilience provides cover for policymakers who argue that the economy can absorb higher rates.
The last time the ECB raised rates after a single-meeting pause was in 2023, when it delivered back-to-back increases before holding steady for over a year. A September hike would mirror that pattern, signaling that the central bank views the current energy shock as persistent enough to warrant further action.
This article is for informational purposes only and does not constitute investment advice.
