The main reason why the ECB may resume raising interest rates is the resurgence of inflationary pressures in the Eurozone. In May, annual inflation in the Eurozone rose to 3.2%, the highest level since the fall of 2023. This was largely driven by rising energy prices linked to the protracted conflict in Iran and its impact on global markets.
However, when assessing the ECB’s potential actions, it is important to understand that the central bank does not base its interest rate decisions solely on the overall inflation rate. The structure of inflation is far more significant.
Changes in the services sector
The greatest attention should be paid to core inflation, which excludes prices for energy, food, alcohol, and tobacco. In May, this indicator stood at 2.5% in the Eurozone, the highest level in 13 months. Meanwhile, services inflation rose to 3.5%, reaching its highest level in the past six months. This indicator is often considered one of the most important in assessing whether inflation is likely to remain high for an extended period.
The rise in service inflation is also closely linked to labour market dynamics. As energy prices rise and household purchasing power declines, workers seek to offset lost income by accepting higher wages. If companies agree to raise wages, they often pass on part of the additional costs to consumers through higher service prices.
It is precisely this dynamic that is currently causing the ECB the greatest concern. An energy price shock does not in itself necessarily mean that monetary policy needs to be tightened. Still, once it begins to affect wages and service prices, the wave of inflation could become difficult to control.
Therefore, the May inflation data can be viewed as a key argument for raising interest rates. Market participants currently have almost no doubt about this scenario—in their view, the probability that the ECB will raise interest rates on June 11 is around 99%.
Will we see more rate hikes this year?
Financial markets are discussing the possibility that the ECB will raise interest rates more than once this year. Currently, there is a 40% probability that the ECB will raise its key interest rates again on July 23 and a 54% probability that rates will be raised on September 10.
However, when forecasting the ECB’s future actions, it is necessary to assess not only inflation but also the outlook for economic growth. In recent months, the eurozone economy has remained in recovery. Still, its growth rate is gradually slowing as geopolitical uncertainty and higher energy prices increase pressure on businesses and consumers.
If the economic slowdown accelerates, the ECB could find itself in a difficult situation. On the one hand, persistent inflation would encourage further monetary policy tightening; on the other hand, raising interest rates too quickly could dampen economic activity. For this reason, it would be premature to speak with certainty about three interest rate hikes.
The good news is that the ECB’s decision should not come as a surprise to the market—this is reflected in the 3-month Euribor rate, which has already risen from around 2% at the start of the year to 2.3%. In other words, the financial markets have essentially already priced in a potential 25-basis-point interest rate hike.