Eurozone inflation hit a record high of 8.1% year-on- year (y/y) in May, boosted by a sharp increase in energy component prices, while the preliminary reading for May points to an even greater 8.1% increase. Cost-side pressures have also been driving food inflation. The April reading is unlikely to represent the peak, despite many countries having cut taxes or offered rebates to offset the immediate impact of higher fuel prices.
Given the recent rise in energy futures, ongoing supply disruption from China, and elevated soft commodity prices, we tentatively forecast that Eurozone inflation will peak at 8.5% y/y in September. After the summer, the base effects from the oil price surge from late last year should start to ease annual comparisons.
Stagflation is a term that keeps many-a-central banker awake at night. Despite decelerating growth prospects, policymakers are becoming more vocal about the need to speed up the tightening timetable for interest rates in an effort to curb inflation. Officials have already indicated that net-asset purchases under the asset-purchase programme (APP) will be concluded by the third quarter, which could pave the way for a rate hike in the second half of this year.
Fears of a wage-price spiral and/or a de-anchoring of inflation expectations, has encouraged members of the Governing Council to issue a raft or hawkish commentary of the past couple of weeks, fuelling market expectations that a summer hike is now on the cards.
We now expect the first ECB rate hike (25bp) will occur in July followed by a further quarter-of-one-percent increase in at the September, October, and December meetings. There is also a possibility that the central bank will raise policy rates one more time in the first quarter of next year before pausing, as growth and inflation starts to trend lower. We do, however, remain cognisant that the hiking cycle could be delayed or slowed should economic activity significantly weaken.