Euro zone inflation hits another record; what are the causes?

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Euro zone inflation reached another record in July and its maximum could still be months awaywhich keeps the pressure on the European Central Bank (ECB) to opt for another big rise in interest rates in September.

The growth of consumer prices in the 19 countries that share the euro accelerated to 8.9% in July, from 8.6% in the previous month, well above expectations of 8.6% and a long way from the ECB’s 2% target, data from Eurostat, the EU’s statistical agency, showed on Friday.

Inflation was initially driven by post-pandemic supply bottlenecks, but more recently the fallout from Russia’s war in Ukraine they have been the main culprits, driving up energy, metal and food prices.

Although high energy prices continue to be a major inflationary factor, energy prices processed foods and services have also skyrocketedsuggesting that inflation is getting wider.

Fearing that price growth will spiral out of control, The ECB raised interest rates by 50 basis points this monthdespite the fact that he had anticipated a smaller increase, and has promised new rate hikes to avoid the start of a spiral of wage prices that is difficult to break.

But inflation is also a dilemma for the bank. Soaring food and energy costs drain savings and ultimately stunt growth, which could push the bloc into recession at worst.

Indeed, Germany, the euro zone’s largest economy, stalled in the second quarter ahead of what could be a difficult third quarter. For its part, the US economy unexpectedly contracted in the second trimester.

Still, the ECB has made it clear that inflation fears trump growth concerns, suggesting that policymakers are willing to raise rates even if it hurts growth, as there is a risk that inflation will take root.

In fact, core inflation, which excludes volatile food and fuel prices, accelerated to 5.0% from 4.6%, more than double the ECB’s 2% target. An even more limited measure, which excludes alcohol and tobacco, rose to 4.0% from 3.7%.

The labor market has never been more tense in the euro zone’s two-decade history, reinforcing the case for persistent price pressures.

The unemployment rate stands at a record low of 6.6%, while employment is at its highest level, suggesting that wage pressures, a precondition for lasting inflation, are already underway.

Markets are now pricing in a 35 basis point rate hike for September, suggesting investors are torn between a 25 basis point move and a 50 basis point move.

They also expect a set of 90 basis point moves by the end of the year, or a hike in the remaining three policy meetings.

However, expectations have been lowered in recent weeks as the recession, possibly induced by the loss of access to Russian gas, is seen as persuading the ECB to follow a softer rate path. The ECB will meet again on September 8.

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