Eurozone inflation stays hot in August, ECB rate debate rages on

FRANKFURT – Eurozone inflation" target="_blank">remained stable at 5.3 percent in August, defying expectations of a decline, and raising concerns that further interest rate hikes may be necessary to beat racing prices and send the economy into recession in the process.

Ahead of the release by Eurostat and upside surprises in national data from Germany and France, analysts had projected inflation to ease to 5.1 percent from 5.3 percent in July.

Importantly however, core inflation excluding energy and unprocessed food, which is seen as a bellwether for future inflation developments, came in weaker than expected and fell to 6.2 percent from 6.6 percent.

ECB officials will meet in two weeks to decide whether to raise interest rates for the tenth consecutive time to 4 percent or pause at 3.75 percent to see how growth and inflation develop.

Latest economic data pointed to the risk of recession in the second half, strengthening the doves’ hand in arguing for a pause. Ahead of the data release, even the hawkish ECB executive board member Isabel Schnabel stressed that growth is weaker then expected and more pain is in store as previous rate hikes are hitting the real economy.  

The Governing Council’s arch-hawk, Robert Holzmann, pounced at the opportunity to make his case for further hiking. Minutes after the data hit, he told the Reuters Global Markets Forum that the persistent inflation may require “another hike or two.”

However, it seems the outcome of September deliberation remains a close call. Investors’ bets on an interest rate move have swung wildly between 40 percent and 60 percent this week. Following the release of the inflation data, investors trimmed those expectations.

“The small upside surprise to eurozone headline inflation in August was entirely due to energy, while the core rate edged down,” said Capital Economic economist Jack Allen-Reynolds in a note to clients. “We don’t think these data will tip the balance of opinion at the ECB decisively towards a hike or a hold at the meeting in two weeks’ time.”

By contrast, Pantheon Macroeconomics economist Melanie Debono argued that the hawks on the Council will read the data as proof that an additional rate hike is needed. “The Bank’s latest forecasts, from June, saw inflation averaging 4.7 percent in Q3; for this to happen inflation in September would need to plunge to below 4 percent,” she said, adding that she continues to bet on a rate hike next month.  

Similarly, ING economist Bert Colijn said that “inflation remains stubborn enough to make ECB hawks uncomfortable” and get their way. “Given the ECB mantra over recent months that doing too little is worse than doing too much in terms of hikes, we still expect another 25 basis point rate rise, despite this being a close call.”

Later Thursday, ECB Vice President Luis de Guindos, a moderate hawk, is scheduled to speak and may offer some insights as to where the scale might tip in two weeks’ time.