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Eurozone inflation rose to yet another record high in May, challenging the European Central Bank (ECB) view that gradual interest rate increases from July will be enough to tame stubbornly high price growth.
Inflation in the 19 countries sharing the euro accelerated to 8.1 per cent in May from 7.4 per cent in April, beating expectations for 7.7 per cent as price growth continued to broaden, indicating that it is no longer just energy pulling up the headline figure.
Prices have risen sharply across Europe over the past year, initially on supply chain problems after the pandemic, then on Russia’s war in Ukraine, suggesting that a new era of fast price growth is now sweeping away a decade of ultra low inflation.
Though headline inflation is now 4 times the ECB’s 2 per cent target, European Central Bank policymakers may be more worried by the rapid rise in underlying prices, which indicate that what was once seen a transitory jump in prices is now getting embedded.
Inflation excluding food and energy prices, watched closely by the European Central Bank, accelerated to 4.4 per cent ear-on-year from 3.9 per cent while an even narrower measure, that also excludes alcohol and tobacco, accelerated to 3.8 per cent year-on-year from 3.5 per cent in April. Hoping to tame inflation, ECB President Christine Lagarde and chief economist Philip Lane have already flagged 25 basis point increases in the ECB’s minus 0.5 per cent deposit rate in July and September.
But some policymakers and economists doubt this will be enough, especially since underlying inflation is showing no signs of abating.
The problem is that once high energy prices seep into the economy, inflation broadens out and gets entrenched, eventually getting perpetuated via a price-wage spiral.
While the evidence of such a trend is not yet clear, a string of data from a jump in negotiated wages to broadening core inflation shows a growing risk.
That is why the central bank governors of Austria, the Netherlands and Latvia have all said that a 50 basis point rate hike in July should be on the table.
Klaas Knot, the head of the Dutch central bank even argued that inflation expectations are now at the upper end of what could still be classified as anchored, indicating that households and investors could soon start to doubt the ECB’s resolve to tame price growth.
The ECB will next meet on June 9 where it will formally end a bond purchases scheme at the end of June and continue to signal the rate hikes.
Meanwhile the eurozone shares hit session lows on Tuesday after data showed inflation rose to a record high in May, spurring bets of bigger interest rate hikes by the European Central Bank (ECB).
The STOXX index of eurozone shares dropped 0.9 per cent and the pan-European STOXX 600 index, which was flat before the data, fell 0.6 per cent.
The euro region’s banks, which typically welcome signs of rising interest rates, slid 1 per cent as investors worried about the hit to the economy from surging prices.
“We see that the high energy inflation is rapidly translating into companies pricing through higher input costs to their consumers as well… it’s clearly a sign of broadening inflation,” said Bert Colijn, senior economist, eurozone at ING.
“This is resulting in market expectations of perhaps ECB acting more quickly,” Colijn said, but added that ING still expects the central bank to hike rates by 25 basis points in July and September.
Investors will closely watch for any change in the ECB’s stance after its meeting next week.
The central bank has so far signalled that it will begin its interest rate hiking cycle in July, with the rate seen rising to 0 per cent or above by September.
The STOXX 600 was set to end May down over 1 per cent, adding to sharp losses earlier this year on concerns over central bank tightening, fallout from the Ukraine conflict and China’s tough COVID-19 curbs.
Fuelling concerns about inflation, Brent crude hit $123 per barrel after Europe vowed to cut most Russian oil imports in the bloc’s toughest sanction on Moscow since the invasion of Ukraine three months ago.
London’s FTSE outperformed with a 0.2 per cent gain, powered by a 6.2 per cent jump in consumer goods giant Unilever after it named activist investor Nelson Peltz to its board.
Dutch speciality chemicals maker DSM jumped 6.3 per cent on plans to merge with Swiss peer Firmenich.