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Why did inflation move back above 3%?

Eurozone inflation rose to 3.3% year on year in August, up from 2.9% in July. According to the preliminary estimate published by Eurostat, it was the highest reading since September 2024. The acceleration was led by higher energy costs.

Energy inflation increased to 14.3% in August from 10.3% in July. In the eurozone, which is a net importer of energy, the cost of crude oil and refined products rose because of the war in Iran and the blockade in the Strait of Hormuz. Disruptions in Europe’s natural gas market also deepened price pressures.

By contrast, core inflation, which excludes volatile items such as energy, food, alcohol and tobacco, showed only a slight decline. The core measure eased to 2.4% in August from 2.5% in July. That picture indicated that the rise in overall inflation was largely driven by energy.

What are markets expecting from the European Central Bank?

After the inflation data, expectations for a rate hike by the European Central Bank (ECB) strengthened further. Data from LSEG showed that, as of Tuesday morning, markets were pricing a 98.9% chance that the ECB would raise rates by 25 basis points at its Sept. 10 meeting, taking the deposit rate to 2.5%.

  • The ECB had raised its main interest rate to 2.25% in June.
  • That move was the first rate increase since 2023.

The June decision was also taken in response to global inflationary pressures linked to Iran. The latest figures showed that the energy shock has once again worsened the inflation outlook, leaving markets broadly priced for another tightening step.

Possible effects of higher rates on the economy

Companies, the housing market and indebted households

Joe Nellis, head of the economics research unit at MHA, said the ECB may be worried that short-term price pressures could become entrenched through wages and services inflation. In Nellis’s view,

“The ECB is facing a dilemma.”

Higher borrowing costs are expected to increase pressure on heavily indebted households, weaken the housing market and make corporate investment more expensive. For small and medium-sized businesses in particular, another rise in financing costs raises the risk that investment plans will be delayed or shelved altogether.

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