© Reuters. FILE PHOTO: European Central Bank (ECB) headquarters building is seen during sunset in Frankfurt, Germany, January 5, 2022. REUTERS/Kai Pfaffenbach/File Photo
By Balazs Koranyi and Jan Strupczewski
BRUSSELS (Reuters) – Euro zone inflation rose to another record high in May, boosting government bond yields as markets saw the data as a challenge to the European Central Bank’s view that gradual interest rate increases from July will be enough to tame fast price growth.
Inflation in the 19 countries sharing the euro accelerated to 8.1% in May from 7.4% in April, beating expectations for 7.7% as price growth continued to broaden, indicating that it is no longer just energy pulling up the headline figure.
“The inflation problem in the euro area is getting worse,” said Commerzbank (ETR:CBKG) economist Christoph Weil. “Today’s price data once again increase the pressure on the ECB to end its ultra-loose monetary policy.”
Euro zone government bond yields rose, because the data boosted expectations that the ECB might accelerate its policy tightening path.
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 four times the ECB’s 2% target, ECB policymakers may be more worried by the rapid rise in underlying prices, which indicate that what was once seen a transitory jump is now becoming embedded.
Inflation excluding food and energy prices, watched closely by the ECB, accelerated to 4.4% year-on-year from 3.9% while an even narrower measure, that also excludes alcohol and tobacco, accelerated to 3.8% year-on-year from 3.5% in April.
“We mechanically update our euro area inflation forecast, and now expect euro area core inflation to peak at 3.9% year-on-year in June and headline inflation to peak at 9.3% year-on-year in September,” Goldman Sachs (NYSE:GS) said in a research note.
Hoping to tame inflation, ECB President Christine Lagarde and Chief Economist Philip Lane have already flagged 25 basis point rises in the deposit rate – now minus 0.5% – 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 becomes 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, when it will formally end a bond purchase scheme from the end of June and continue to signal rate hikes.
Euro zone inflation hits new record, adding to case for big ECB rate hikes