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Seven Month Run of Record High Euro Zone Inflation Set to Prompt ECB Action

Inflation continues to rise to new record highs in the Euro zone, as the conflict in Ukraine roils markets for energy and commodities.  

Euro zone inflation rose to 8.1% in the month of May, according to preliminary data from the European statistics office.  

This marks the seventh consecutive month that inflation in the Euro zone has breached a new record high, after posting a print of 7.4% in April.  

The war in Ukraine is the primary driver of raging inflation in the Euro zone, as stern measures adopted by EU nations against Russia undermines energy supplies.  

Crude oil prices surged after EU leaders agreed on Monday to a ban on 90% of crude oil sourced from Russia by the end of 2022.  

Charles Michel, president of the European Council, said that the move would have an immediate impact upon 75% of oil imports from Russia.  

The latest record-high reading for Euro zone inflation arrives just as other advanced economies – including the US and UK, grapple with their own breakneck inflation. 

The US Labor Department reported in early May that consumer prices had surged 8.3% compared to the same period last year. In March year-on-year (YoY) inflation was 8.5%, for its highest level since 1981.  

In the UK inflation could be on the verge of entering two digit territory, after posting a 9% rise in the 12 months to April, up from 7% in March.  

The Federal Reserve has already taken concerted action to curb the highest inflation levels that the US has witnessed in more than two decades.  

In March the Fed hiked its benchmark interest rate by 0.25 percentage points, for the first increase since December 2018.  

In early May the Fed announced a hike of 0.5 percentage points, lifting the benchmark interest rate to a target range of 0.75% and 1%, for the largest increase since 2000.  

The market currently anticipates more 0.5 percentage point rates hikes from the Fed. US stocks actually posted a bounce in the wake of the latest round of Fed meeting minutes which confirmed this pace of increase, as opposed to a 0.75 percentage hike that many have feared from a hawkish Jerome Powell.  

Until now the European Central Bank (ECB) has been more dilatory in its actions, despite the Euro zone being directly impacted by the Ukrainian conflict, which is one of the primary drivers of global inflation.  

Combined with the lax attitude of the Bank of Japan (BOJ) and rising US interest rates, this has helped to support the value of the greenback since the start of the year. The US Dollar Index is currently up over 6% year-to-date and nearly 12% higher compared to a year ago.  

The unbroken run of record inflation prints in the Euro zone is likely to prompt the ECB to follow the lead of the Fed in adopting far more hawkish action.  

In May ECB President Christine Lagarde said she foresees a rate rise at its July meeting.  

“We are likely to be in a position to exit negative interest rates by the end of the third quarter, wrote Lagarde in a blog post.  

Observers expect a 25 bps increase, while some are calling for a 50 bps rise.  

Money markets expect the ECP to push through a cumulative 115 bps increase in rates by the end of 2022, as well as see a 40% change of a 50 bps hike in July. 

Goldman Sachs Chief European Economist Jari Stehn sees the ECB lifting its deposit rate from -0.5% to 1.5% in June 2025.  

The Euro’s near-term fate will be determined by the actions of the ECB. Aggressive increases to interest rates will provide the Euro with support, while a lack of decisive action from the ECB will drag the currency lower.