Eurozone inflation hits 3.3% as Iran war broadens price pressures

Inflation in the euro zone's four largest economies exceeded the ECB's 2% target for a third straight month in May, as the Iran war's energy shock began feeding into a wider range of consumer prices.

The Iran war's energy shock is embedding itself into euro zone consumer prices, with national inflation readings across France, Italy, Spain and Germany all holding above the European Central Bank's 2% target for a third consecutive month in May.

"We are not at the peak yet," said Nadia Gharbi, a senior economist at Pictet Wealth Management, who expects euro zone inflation to rise until August. "A lot will depend on the situation in the Middle East and we have as a baseline that the situation will normalise by the end of June."

French inflation accelerated to 2.8% from 2.5%, while Italy's rose to 3.2% from 2.7%. Spain held steady at 3.2%, and readings fell in most German states that have reported, including Bavaria and Baden-Wuerttemberg, after Berlin implemented a fuel discount for May and June. Brent crude traded at $92 a barrel, down from a war peak of $118 but still well above the pre-conflict level of around $70.

The data cements the case for a rate hike when the ECB meets on June 11, with swaps pricing a 92% probability of a 25-basis-point increase. The broadening of price pressures beyond fuel — into transport, entertainment and fresh food — threatens to make inflation stickier than initially expected, complicating the ECB's path back to its 2% target.

Core pressures build across southern Europe

Underlying inflation measures, which strip out volatile energy and food costs, also moved higher. Italy's core rate rose to 1.8% from 1.6%, while Spain's climbed to 2.9% from 2.8%. France continued to see deflation in manufacturing prices, a dynamic that Bersingeco economist Sylvain Bersinger said strengthens the view that the current shock should be smaller than the one that followed the COVID pandemic and Russia's invasion of Ukraine in 2022.

Both Spain and Italy reported strong increases in the price of transport and entertainment activities, a likely sign of the knock-on effect of higher fuel costs. France saw a 4.1% jump in the cost of fresh food and a slight increase in services inflation.

Euro zone-wide data due on Tuesday is expected to put headline inflation at 3.3%, with a core gauge excluding energy, food, alcohol and tobacco at 2.4%. The last time euro zone inflation ran above 3% for multiple months was during the 2022-2023 energy crisis, when the ECB delivered a series of aggressive rate hikes that pushed its deposit rate to a record 4%.

Rate path hinges on Middle East

ECB Chief Economist Philip Lane said the impact of the Iran war will take longer to show in the labor market, and the "second round" of the energy shock on the euro zone will persist for a while, according to remarks reported Thursday. The Eurozone's May economic sentiment indicator rose to 93.5 from 93.0, beating expectations of no change, though the improvement was concentrated in the services sector while manufacturing sentiment weakened.

Hopes of a deal to end the war between the United States and Iran have pushed oil prices down substantially since late April, when Brent peaked at $118. A sustained decline toward pre-war levels of around $70 would ease the inflation outlook significantly, but JPMorgan economist Raphael Brun-Aguerre cautioned that the data "so far hints at a further rise in headline inflation, and some increase in core inflation."

If the conflict persists through the summer, the ECB may need to extend its tightening cycle beyond June, a scenario that would weigh on the euro zone's already sluggish growth outlook. The euro zone economy expanded just 0.3% in the first quarter, and higher borrowing costs risk further dampening investment and consumption.

This article is for informational purposes only and does not constitute investment advice.