Price pressures across the euro area intensified in May, pushing annual inflation to 3.2%—the highest reading since September 2023—and cementing expectations that the European Central Bank will raise interest rates at its next meeting. The increase, driven by persistent energy costs and a worrying jump in services inflation, underscores the difficulty the ECB faces in bringing price growth back to its 2% target.
According to Eurostat's flash estimate released on Tuesday, the headline figure matched economists' forecasts and rose from 3.0% in April. Energy prices remained the dominant driver, climbing 10.9% year-on-year, barely changed from 10.8% the previous month. The disruption from the Strait of Hormuz blockade continues to ripple through energy markets, keeping costs elevated across the bloc.
Services inflation accelerates, troubling policymakers
More concerning for the ECB's Governing Council was the acceleration in services inflation, which jumped to 3.5% from 3.0% in April. This measure is closely watched as an indicator of domestically generated price pressures, and its rise suggests that the energy shock is beginning to seep into the broader economy. Core inflation, which excludes energy, also climbed to 2.4% from 2.2%.
The picture varied across member states. Spain recorded the fastest pace among the larger economies at 3.6%, followed by Italy at 3.3%, where inflation has accelerated sharply from 2.8% a month earlier. France stood at 2.8%, and Germany, the bloc's largest economy, at 2.7%. Portugal was one of the few countries to register an easing, slipping to 3.1% from 3.3% in April.
Consumers are bracing for prices to keep climbing. According to the ECB's Consumer Expectations Survey for April, median expectations for inflation over the next 12 months held at 4.0%, double the central bank's target. The perceived rate of inflation over the previous year jumped to 4.0% from 3.5%. Longer-term expectations remained somewhat better anchored: three-year expectations declined slightly to 2.9%, while five-year expectations stayed at 2.4%. However, the ECB noted that uncertainty surrounding inflation expectations remained elevated.
The survey also highlighted a deteriorating economic outlook. Consumers became more pessimistic about growth prospects over the next year, while expectations for spending growth increased, suggesting households anticipate further pressure on living costs. This trend is reflected in the ongoing challenge of high grocery bills, as explored in Why Your Grocery Bill Stays High Even as Inflation Slows Across Europe.
Markets almost fully price in a June hike
Financial markets increasingly believe the ECB has little choice but to tighten policy further. Prediction market Polymarket currently assigns a 97% probability to a 25-basis-point increase in the ECB deposit rate at next week's Governing Council meeting. Several economists share that view.
ABN AMRO senior economist Bill Diviney also expects consecutive hikes over the next two meetings. "For an institution that has moved away from forward guidance, this is as close to a signal of a coming rate hike as you are going to get," he said, referring to recent comments by ECB President Christine Lagarde.
ING's global macro head Carsten Brzeski argues that the June meeting increasingly resembles an "insurance hike" designed to prevent inflation expectations from becoming unanchored. "Even if the war in the Middle East were to end tomorrow, the damage to inflation has already been done," Brzeski said. "Inflation has started – and will continue – to hit the eurozone economy."
Joe Nellis, economic adviser at MHA, believes the ECB now faces an increasingly difficult trade-off. "With this uptick in inflation, the ECB is increasingly likely to raise interest rates by 0.25 percentage points next week," Nellis said. Yet higher borrowing costs could further weigh on business investment, household spending, and highly indebted governments. "The ECB is facing a difficult balancing act. Higher interest rates will add further pressure on businesses already holding back on investment and on households facing rising mortgage repayments and stretched budgets," he added.
Bank of America economist Ruben Segura-Cayuela continues to expect two quarter-point rate increases in June and July, taking the deposit rate to 2.5%, although he acknowledges that weaker economic data could delay the second move until September. For currency markets, Enrique Díaz-Alvarez, chief economist at Ebury, said ECB officials had telegraphed a June move clearly enough that little could now derail it, while seeing minimal room for further tightening once energy prices fall and as the United States and Iran edge towards an agreement to reopen Hormuz. The euro has not rallied as much as the retreat in energy prices might suggest, he added, held back by the weak business confidence visible in the PMIs.
The central debate is whether the energy shock will fade as a transitory episode or whether disruption to supply chains generates the kind of second-round effects that the ECB fears most. For the ECB, next week's decision looks settled. The harder question is how long the tightening lasts once the supply shock that triggered it begins to subside. This dynamic is also playing out in national energy strategies, such as How a German Village Cut Energy Costs to 12 Cents and Beat the Hormuz Crisis, which highlights local resilience amid global pressures.
