Italy and France's June CPI slowed more than expected, cooling expectations of consecutive ECB rate hikes.

Easing tensions between the US and Iran have led to a decline in energy prices, while inflation in Europe cooled more than expected, lowering the urgency for further rate hikes by the European Central Bank. However, the decision-makers have not yet declared victory over inflation. Considering that core inflation remains resilient and geopolitical risks persist, the ECB reiterated that it will base subsequent policy decisions on incoming data.

Data released on Tuesday showed that June inflation in both France and Italy was lower than expected, mainly due to a remarkable drop in energy prices. France's inflation rate fell from 2.8% in May to 2.0%, below the forecast of 2.3%; Italy’s rate declined from 3.2% to 3.0%, while markets had expected it to remain flat.

Following the data, market expectations for the ECB to slow its tightening pace increased. On the same day, Pierre Wunsch, ECB Governing Council member and Governor of the Belgian National Bank, stated, that after the US-Iran agreement, the key factors that previously drove inflation have "basically faded," and the strong need for rate hikes seen in June has weakened.

French and Italian inflation both below expectations, energy prices drive inflation decline

According to harmonized EU standards (HICP) published by Insee, French consumer prices rose 2.0% year-on-year in June, a significant drop from 2.8% in May and below economists’ expectations of 2.3% as surveyed by The Wall Street Journal.

Insee stated that the cooling in inflation mainly stemmed from a marked slowdown in energy price increases, especially declines in petroleum product prices; meanwhile, service prices also rose at a slower pace.

Similarly, Italy’s national statistics agency, Istat, reported that June's inflation rate dropped to 3.0%, below May's 3.2% and better than market expectations for an unchanged rate. Analysts believe that the simultaneous decline in inflation in both countries reflects that the adjustment in international energy prices in June is gradually being transmitted to European consumers.

Previously, as the US and Iran reached a temporary peace agreement in mid-June, markets bet on the restoration of normal shipping in the Strait of Hormuz, causing international oil prices to keep falling and reaching their lowest levels since the outbreak of the conflict.

Wunsch: The rationale for another rate hike is less compelling than in June

As inflation data was released, ECB officials also sent out more cautious policy signals.

ECB Governing Council member Pierre Wunsch said Tuesday that the factors that initially triggered the inflation shock have basically disappeared as the US and Iran reached an agreement. He noted that markets still expect the ECB to raise rates by another 25 basis points this year, but that compared to June, the necessity for such action has decreased:

"We probably still need another rate hike—the market sees it that way—but we're not as convinced as we were in June."

However, Wunsch did not completely rule out the possibility of further tightening. He emphasized that if future data indicate another rate hike is necessary, the ECB will not delay for long, but this does not mean the action will definitely come in July.

He said:

"We know that inflation will remain above target in the coming quarters. If the data shows another rate hike is needed, I prefer to act as soon as possible, but I won't commit to a specific time."

The ECB remains cautious; core inflation and geopolitical risks are still variables

Although the decline in energy prices has eased short-term inflationary pressure, the ECB has not altered its overall cautious stance.

ECB President Lagarde reiterated on Tuesday that the rate hike that began in June—the first in nearly three years—was based on the central bank's latest forecasts. According to the ECB, if policy is not tightened further, the eurozone’s inflation rate will remain above the 2% target in both 2027 and 2028.

Meanwhile, core inflation in the eurozone unexpectedly rose to 2.5% in May, indicating that rising energy prices can still generate second-round inflation effects through the services sector and other areas. Wunsch also acknowledged such second-round effects exist, although currently he is "not overly concerned."

In addition, the situation in the Middle East still poses recurring risks. Recently, regional tensions have flared again, and markets remain concerned that shipping in the Strait of Hormuz could face new disruptions, making future energy price trends highly uncertain.

Notably, data released Monday showed that Spain’s inflation in June remained above expectations, with electricity and natural gas prices continuing to support overall prices. Eurozone-wide inflation data for June will be released on Wednesday, which may further influence market judgments of the ECB’s next policy moves.

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