Eurozone July CPI Rises to 2.9%, Core CPI Rebounds, ECB September Rate Hike Imminent

Eurozone inflation has climbed again after remaining above target for several consecutive months. Coupled with an unexpected rise in core inflation, the probability of a European Central Bank (ECB) rate hike in September has risen to 85%.

Inflation data for July released by Eurostat on Friday showed that the Eurozone's annual CPI rose to 2.9%, higher than June's 2.8%, consistent with expectations from a Reuters survey. The annual growth rate of energy prices expanded from 8.5% to 10%, serving as the main driver behind this round of inflation rebound, underpinned by soaring oil prices triggered by the war in the Middle East.

Of greater concern to the market was that core CPI, excluding food and energy, unexpectedly rose from 2.4% to 2.5%, while services inflation also edged up slightly from 3.2% to 3.3%, indicating that price pressures have begun to permeate the broader economy. ECB President Christine Lagarde warned last week, after keeping interest rates unchanged at 2.25%, that the spillover effects of energy shocks might be stronger than expected, stating that the bank would remain "highly vigilant" regarding broader price pressures in the coming weeks.

Data from the interest rate swap market shows that traders are currently pricing in an approximately 85% probability of a rate hike in September and are betting on one to two additional 25-basis-point hikes within the year.

Energy Shock is the Core Driver, Oil Price Trends Become Key Variable

The direct source of this inflation resurgence is energy. Affected by the ongoing conflict in the Middle East pushing up global oil prices, energy prices in the Eurozone rose by 10% year-on-year in July, a significant acceleration from June's 8.5%. Brent crude oil quickly rebounded after briefly falling below pre-war levels in late June, with current prices accumulating a gain of over 22% since the beginning of the month.

Bert Colijn, Chief Economist at ING, pointed out that there is still "ample room for upside" in inflation in the coming months, and if oil prices remain at current levels, the August reading will be "significantly higher than July's." Preliminary signs of strengthening wage pressure have also emerged, further increasing the risk of persistent inflation.

On the offsetting side, food inflation continued its downward trend for the year, dropping to 1.2% in July; the price increase for non-energy industrial goods remained at a low level of 0.9%, reflecting to some extent that import prices from China remain relatively low. The euro barely reacted to the data release, slipping slightly by 0.1% to $1.152.

July Data Not Decisive, But Has Put ECB on Rate Hike Track

Although inflation data exceeded expectations, Reuters cited analysts' views that the July data itself would not be the "decisive factor" for ECB policy—before the monetary policy meeting on September 10, policymakers will also receive the August inflation readings, and the high volatility of oil prices leaves room for uncertainty.

However, the overall judgment of the market and analysts has converged. Kamil Kovar, Eurozone Forecast Director at Moody's Analytics, stated that given the developments in the Middle East in July, Friday's inflation data would "firmly put the ECB on the path to a September rate hike." Neil Birrell, Chief Investment Officer at Premier Miton, remarked that stopping the ECB from acting in September would require a "significant reversal in events and outlook."

The ECB had previously sent clear signals: economic trends align with its "baseline scenario," which inherently presupposes a rate hike in September. The second-quarter GDP growth of 0.4%, which significantly exceeded expectations, has also further alleviated external concerns that rate hikes might suppress economic growth.

Economic Resilience Eases Rate Hike Concerns, But Disagreement Remains on Subsequent Path

The Eurozone's GDP grew by 0.4% quarter-on-quarter in the second quarter, double the expected rate. Inflation rose synchronously in France, Germany, and Spain, and with the exception of Estonia, inflation in all member states remained above the ECB's 2% target. This marks the fifth consecutive month that Eurozone inflation has exceeded the target, providing a stronger basis for policy tightening.

However, analysts disagree on the pace of subsequent rate hikes. Financial markets have fully priced in two rate hikes in October and next April; economists generally hold a more cautious stance, with most expecting only one additional hike, reasoning that rising energy prices have not yet triggered a "second-round effect" on wages and prices, and a relatively soft labor market implies that wage pressure will remain moderate.

Services inflation has remained above the ECB's target for more than three consecutive years. This structural pressure will be a key indicator for the ECB to assess whether inflation is truly under control and will directly influence its policy direction after September.