Inflation hits 3.2% in the euro zone as energy costs climb higher

Euro zone inflation rose to an estimated 3.2% in May, driven by double-digit energy price growth, official data showed on Tuesday.

The print, which was in line with forecasts in a Reuters poll of economists, is expected to lock in expectations of an interest rate hike at next week’s European Central Bank meeting.

Energy costs represented the highest annual rate of inflation in May, according to the flash data, with prices rising by 10.9% — a slight rise from the euro zone’s 10.8% energy price growth recorded the previous month.

Services inflation rose to 3.5% from 3% in April, while food, alcohol and tobacco prices cooled to 2% from 2.4% the previous month.

Inflation rates also varied drastically between individual markets. Germany, Europe’s biggest economy, saw annual inflation fall to 2.7% in May from 2.9% in April. But Greece and Lithuania’s annual inflation rates rose above 5% last month. In France, annual inflation rose from 2.5% in April to 2.8% in May.

Tuesday’s print showed inflation in Europe is continuing to rise above the European Central Bank’s 2% target as oil and gas prices remain elevated in the wake of the U.S.-Iran war.

Inflation in the euro zone jumped to 3% in April, up from 2.6% in March. Prior to the outbreak of the conflict in Iran, inflation in the euro area had dipped below the 2% threshold.

Europe is particularly vulnerable to energy shocks as a major net energy importer.

Markets are currently pricing in a 94% chance of the ECB hiking its key interest rate by 25 basis points at its meeting later this month, according to LSEG data.

Following the data release, the euro was flat against the dollar at around $1.164. The yield on Germany’s 10-year bund, broadly seen as a benchmark for the euro zone, fell by 6 basis points.

Carsten Brzeski, global head of macro at ING, said in a note on Tuesday morning that the May inflation data paves the way for an ECB rate hike next week.

“A week ahead of the next ECB meeting, this is the expected uptick in inflation that will motivate the central bank to decide on an ‘insurance’ hike,” he said.

Brzeski added that the Iran war-induced energy shock had “become more permanent,” but noted that oil prices remain lower than levels forecast by many market watchers under a more adverse scenario regarding the length of the war.

“Nevertheless, for inflation in the eurozone, the only way is currently up,” he said. “Not a sharp up but a rather moderate and gradual lift. While knock-on effects from higher energy prices on other prices, like transportation and food, will be hard to avoid, the latest survey-based inflation expectations have come down a bit.”