Europe's inflation heats up again! Prices in France and Spain hit new highs since 2024, with the ECB poised for a rate hike in June.

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Against the backdrop of the ongoing Middle East war driving up energy costs, inflationary pressure across the eurozone is intensifying, and expectations for a European Central Bank rate hike in June have become almost certain.

In May, both France and Spain saw their inflation rates reach the highest levels since 2024, while Italy’s price increase for the same month hit the highest since 2023. These data points further reinforced ECB officials’ inclination toward rate hikes—from hawkish Governing Council member Isabel Schnabel to the more dovish Chief Economist Philip Lane, both signaling that they believe there is a need to raise borrowing costs for the first time since 2023.

The market response has been clear. Investors are now almost certain that the ECB will raise the deposit rate from 2% to 2.25% on June 11, and expect another hike within the year. Currently, inflation concerns clearly outweigh policymakers' worries about economic growth.

Meanwhile, ECB Governing Council member and Bank of Italy Governor Fabio Panetta, in his important annual speech on Friday, acknowledged the need for action but also called for not pre-committing to a future tightening path, so as to maintain policy flexibility for the ECB.

Inflation speeds up across the board: France, Italy, Spain all exceed 2% target

France's May Consumer Price Index (CPI) rose 2.8% year on year, slightly below market expectations; Spain saw a 3.6% increase, in line with expectations, both being the highest levels since 2024. Italy’s May inflation rate rose to 3.3%, also the highest since 2023. All three data points were released by local statistics agencies on Friday.

Analysts pointed out that rising energy costs are the main driver of this round of accelerating inflation, and this pressure is closely related to Trump’s military action against Iran three months ago, which disrupted Middle East energy supplies.

From a broader perspective, Germany’s May inflation data are also under scrutiny. Preliminary figures from states such as North Rhine-Westphalia, Bavaria, and Baden-Württemberg indicate that price growth in Germany may slow but will still remain well above the ECB’s 2% policy target. Inflation data covering all 21 eurozone member states will be released next week, with the market expecting it to deviate further from April's 3% rate.

The accelerated release of this inflation data comes as internal ECB discussions have also clearly shifted. Minutes from the April policy meeting, released Thursday, show that some officials no longer opposed rate hikes at that time, signaling an emerging internal consensus on a policy shift.

If the ECB announces a rate hike at its decision meeting on June 11, it will be the first increase since September 2023, marking a clear reversal from the prior eight consecutive rate cuts. The market is currently pricing in one more rate hike this year, reflecting investors’ view that inflation risks are outweighing growth concerns.

Panetta: Supports action, but rejects pre-set path

At the Italian central bank’s annual report presentation in Rome on Friday, Panetta stated that the ongoing Iran war, rising inflation expectations, shrinking fuel inventories, and other supply disruption risks all point to the necessity of taking certain actions. "The forward-looking outlook seems to require a recalibration of monetary policy stance to address persistent inflation risks," Panetta said.

However, he also emphasized: "It remains essential not to be constrained by a pre-set path." This statement diverges from some market participants’ expectations for clear signals of consecutive rate hikes, and also hints at continuing internal disagreement at the ECB over the pace of rate hikes.

Panetta also warned of the risk of a wage-price spiral, but pointed out that current wage data show no alarming signals: "Despite medium-term inflation expectations facing pressure, they remain firmly anchored at target, and there are currently no signs of wage strain." He stressed, "Once a wage-price spiral is triggered, it will be harmful and costly." Panetta's comments are likely to be his last major public remarks before next week’s pre-decision quiet period.

Economic outlook dims; France’s contraction intensifies ECB’s dilemma

While inflation is heating up, some economies are seeing worsening growth data, putting the ECB in an even more challenging policy environment.

Revised data from the French statistical agency released Friday showed the country's GDP shrinking by 0.1% in Q1, worse than the previously reported zero growth. Leading indicators for May also suggest declining consumer confidence and a trend toward business activity contraction in France.

As for Italy, Panetta warned that the Iran war "has already shaken an already fragile economic outlook." He expects Italian economic activity to remain weak in the coming months, "and in the worst-case scenario, the economy may stagnate or even contract."

He also warned about the macro background of rising global bond yields:

"The overall picture remains fragile. Against a backdrop of high public debt and rising vulnerabilities among non-bank financial intermediaries, even a limited shock could have a domino effect."

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