Eurozone inflation climbs above 3%, ECB rate hike looms

Eurozone inflation surged to 3.2% in May, a faster-than-expected acceleration that intensifies pressure on the European Central Bank to tighten monetary policy. The latest preliminary data from Eurostat signals a growing challenge for the ECB as it aims to maintain price stability.

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It is almost inevitable that the central bank will raise its key interest rate next week, as inflation has been significantly faster than the price stability target for a longer period.

Financial markets now consider a 0.25 percentage point interest rate increase at the ECB's upcoming meeting to be nearly certain. "It is almost inevitable that the central bank will raise its key interest rate next week, as inflation has been significantly faster than the price stability target for a longer period," said Minna Kuusisto, chief economist at Danske Bank. She added that core inflation's faster-than-expected rise in May further supports this move.

Kuusisto believes the ECB might also raise rates in July. The central bank's target is 2% inflation in the medium term. Inflation has been climbing since March, partly due to energy supply disruptions linked to the conflict in Iran. The last time inflation exceeded 3% was in September 2023. Rising prices disproportionately affect low-income households, as a larger portion of their income goes toward consumption, and high inflation also hinders businesses.

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The central bank would be justified in raising its key interest rate next week, especially because core inflation accelerated in May.

Juho Koistinen, forecasting manager at the research institute Labore, agreed that a rate hike is justified, particularly due to the acceleration in core inflation. In May, energy prices rose 10.9% year-on-year, food and alcohol 2.0%, manufactured goods 0.9%, and services 3.5%. Core inflation, closely watched by central banks and economists, stood at 2.5% in May, up from 2.2% in April. Analysts surveyed by Reuters had predicted 2.4% for May. Core inflation excludes the volatile prices of energy and food, making it a key indicator of underlying price pressures. Jari Hännikäinen, a market economist at OP-Pohjola, views the upcoming rate hike as almost certain and anticipates another 0.25 percentage point increase in September.

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The rate hike next week is almost certain. The biggest question is when the ECB will raise the key interest rate again after next week. Our view is that a 0.25 percentage point rate hike is also expected in September.