Eurozone August CPI surges to a three-year high, is an ECB rate hike next week a certainty?

Eurozone inflation has accelerated again under the impact of energy prices, making a September rate hike by the European Central Bank nearly certain. Meanwhile, the unexpected decline in core inflation means there is still disagreement over the policy path after September.

On Tuesday, according to data released by Eurostat, the Eurozone Consumer Price Index (CPI) rose 3.3% year-on-year in August, higher than July’s 2.9% and reaching the highest level since September 2023, consistent with Bloomberg's market expectations. The market has now almost completely priced in a 25 basis point rate hike by the European Central Bank on September 10, raising the deposit rate to 2.50%.

This round of inflation rebound was primarily driven by energy prices. Ongoing conflicts in the Middle East continue to push up crude oil and natural gas prices, which are gradually being transmitted to broader consumption. European Central Bank Executive Board Member Isabel Schnabel stated last week that borrowing costs need to rise further to bring inflation back to target levels.

Governor of the Austrian Central Bank Martin Kocher also said on Tuesday, “The upside risk to inflation has recently risen again.” If the European Central Bank's latest forecasts confirm this, “it will be necessary to raise rates again in the near term.”

Energy Prices Dominate Inflation Rebound, Core Inflation Unexpectedly Falls

This round of accelerated inflation is almost entirely driven by energy costs.

As crude oil and natural gas prices rose, refiners’ profit margins expanded simultaneously, and energy sub-component prices increased significantly. Italy’s August inflation rate rose from 2.9% to 3.2%, while Spain’s previously announced August inflation rate surged to 4.5%. The inflation rates of Germany and France, the two major economies in the Eurozone, also accelerated.

But the core inflation rate, excluding food and energy, unexpectedly fell from 2.5% to 2.4%; service sector inflation also dropped from 3.3% to 3.0%.

David Powell, Bloomberg’s lead Eurozone economist, pointed out the sharp divergence between rapidly rising overall inflation and falling core price increases, supporting the view that the European Central Bank will not dramatically tighten policy as currently priced in by financial markets. As the labor market cools, the transmission of commodity prices to goods and services prices may be limited, but if the energy shock lasts longer, another rate hike in December could still be back on the agenda.

September Rate Hike Nearly Certain, Divergence Remains on Subsequent Policy Path

Tuesday’s data essentially matches the European Central Bank’s previous expectations, so raising the deposit rate to 2.50% on September 10 is expected to be a relatively straightforward decision. The market focus has also gradually shifted from “Will there be a rate hike in September?” to “Is 2.5% the end point?”

European Central Bank Chief Economist Philip Lane previously stated that 2.5% is at the upper end of the so-called “neutral range.” Some officials recently believe that if the energy shock persists, policy rates may need to rise above 2.5%; but Executive Board Member Piero Cipollone called for caution, reasoning that the second-round inflation effects caused by war have not yet fully emerged.

Currently, most economists expect the European Central Bank will likely pause after raising rates in September, keeping rates at around 2.5%. A weak labor market, lack of significant acceleration in wage growth, and sluggish economic growth of around 1% all limit the space for further policy tightening.