Eurozone CPI surged to a three-year high in August, making an ECB rate hike next week a certainty?

Eurozone inflation accelerated again due to energy price shocks, making a September rate hike by the European Central Bank almost a certainty. Meanwhile, a surprise decline in core inflation also indicates continued market disagreement regarding the policy path beyond September.

On Tuesday, data released by Eurostat showed that the Eurozone's Consumer Price Index (CPI) rose 3.3% year-on-year in August, up from 2.9% in July, reaching its highest level since September 2023 , in line with market expectations in a Bloomberg survey. The market has now largely priced in the European Central Bank's 25 basis point rate hike on September 10 , raising the deposit rate to 2.50%.

This inflation rebound is primarily driven by energy prices. The ongoing conflict in the Middle East has pushed up crude oil and natural gas prices, which are gradually being transmitted to broader consumer demand. European Central Bank Executive Board member Isabel Schnabel stated last week that borrowing costs need to rise further to push inflation back to the target level.

Austrian central bank governor Martin Kocher also stated on Tuesday that "upside risks to inflation have recently increased again." If the European Central Bank's latest forecast confirms this assessment, "another rate hike will be necessary in the near future."

Energy prices led the inflation rebound, while core inflation unexpectedly fell.

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

As crude oil and natural gas prices rise, refiners' profit margins expand accordingly, leading to a significant increase in energy component prices. Italy's inflation rate rose from 2.9% to 3.2% in August, while Spain's previously announced August inflation rate climbed even higher to 4.5%; inflation rates in the Eurozone's two largest economies, Germany and France, also accelerated.

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

David Powell, senior eurozone economist at Bloomberg, points out that the sharp rise in overall inflation and the decline in core price increases are in stark contrast, supporting the assessment that the European Central Bank will not tighten policy as drastically as financial markets are currently pricing in. With the labor market cooling, the transmission of commodity prices to goods and services prices may be limited, but if the energy shock persists longer, another rate hike in December could still be on the agenda.

A September rate hike is almost a certainty, but disagreements remain regarding the subsequent policy path.

Tuesday's data largely met the European Central Bank's previous expectations, therefore, raising the deposit rate to 2.50% on September 10 is expected to be a relatively smooth decision. Market focus has gradually shifted from "whether or not there will be a rate hike in September" to "whether 2.5% is the final step."

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 continues, the policy rate may need to rise above 2.5%; however, Executive Board member Piero Cipollone called for caution, arguing that the second round of inflation triggered by the war has not yet fully materialized.

Currently, most economists expect the European Central Bank to likely pause its rate hike in September, keeping rates around 2.5%. A weak labor market, slow wage growth, and a sluggish economic growth rate of approximately 1% all limit the scope for further policy tightening.

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