European inflation is accelerating! The CPI growth rates in France and Spain reached a two-year high in May. The European Central Bank is highly likely to raise interest rates next month.

With the continuous impact of the Middle East situation on the global energy market, inflation pressures in Europe have once again significantly intensified. In May, inflation rates in France and Spain both rose to their highest levels since 2024, further strengthening market expectations for the European Central Bank to restart a rate hiking cycle. Data shows that in May, France's Consumer Price Index (CPI) rose by 2.8% year-on-year, slightly lower than the market's expectation of 2.9%, but still reaching its highest level in nearly two years; Spain's May CPI rose by 3.6% year-on-year, in line with market expectations, also setting a new high since 2024. Soaring energy prices remain a key factor driving price increases, especially as natural gas and fuel costs continue to rise. Analysts point out that since the United States took military action against Iran three months ago, tensions in the Middle East have continued to escalate, concerns about crude oil and natural gas supply have pushed European energy prices significantly higher, and the Eurozone economy is gradually falling into a risk of "high inflation + weak growth." European Central Bank Shifts to Hawkish Stance: Rate Hike in June Likely The inflation data from France and Spain set the tone for the major Eurozone economies' price reports on that day. The market is currently paying high attention to the subsequent data releases from Germany and Italy. Economists expect that Germany's May inflation rate may slightly retreat but still remain around 3%; Italy may see a further increase. The Eurozone's overall inflation data to be released next week is also expected to be higher than the 3% in April. This means that the European Central Bank is getting farther away from its 2% inflation target. Recently, there has been a noticeable increase in hawkish voices within the European Central Bank. From Executive Board member Isabel Schnabel to Chief Economist Philip Lane, policymakers have all hinted that the ECB may need to restart rate hikes for the first time since 2023. The minutes of the ECB's April meeting showed that while the decision-makers chose to remain still at the time, officials were already beginning to worry about the energy shock triggering a "second-round inflation effect." The minutes stated, "Turning a blind eye is becoming increasingly less appropriate." Some officials even believe that the current focus of the discussion is no longer "whether to hike rates," but "when is the most appropriate time to raise them." Currently, the financial markets almost unanimously expect the European Central Bank to raise the deposit rate from the current 2% to 2.25% at its monetary policy meeting on June 11. Swap market data shows that the probability of a 25 basis point rate hike on June 11 is around 90%, and there is also a widely digested expectation for another rate hike before the end of the year. The latest analysis from institutions like the French Industrial Bank shows that the market has fully priced in two rate hikes by 2026, with about a 50% probability of a third action. Following the release of the April meeting minutes, the euro against the dollar received some support, trading near 1.1650 during the Asian session on Friday. The energy shock is spreading to core inflation The accelerating trend of inflation in the two countries is not isolated. According to the final assessment released by Eurostat earlier, the Eurozone's year-on-year inflation rate in March 2026 has been revised upward to 2.6%, reaching the highest level since July 2024. In April, the Eurozone's inflation rate further rose to 3%, with energy prices once again being the driving force. The April inflation rates for France, Germany, Italy, and Spain were 2.5%, 2.9%, 2.8%, and 3.5%, respectively - all reflecting strong transmission of energy shocks to the entire Eurozone. The latest data from the OECD shows that the energy inflation rates in France and Germany have exceeded 7%, and the suction effect of energy prices on consumer prices has not yet peaked. The surge in energy prices is not isolated in the global market. Since the military conflict between the US and Iran erupted at the end of February 2026, the price of crude oil has climbed from around $60 per barrel to nearly $120, almost doubling. The blockade of the Strait of Hormuz and ongoing issues with passage have not been properly resolved, resulting in significant fluctuations in oil prices due to the back and forth between peace agreement expectations and escalating conflicts. On May 25th - four days before the release of inflation data from France and Spain - Brent crude oil futures plummeted by more than 8% to $94.11 per barrel on rumors of a US-Iran nuclear deal, but quickly rebounded on the 26th due to new conflicts casting a shadow over negotiation prospects. As of May 28th, Brent crude oil futures were trading at $97.29 per barrel, with volatility during the week far exceeding historical averages. The transmission of energy prices to the consumer side is accelerating. The tax relief measures implemented by the Spanish government to address the energy crisis are scheduled to expire on May 31, 2026, at which point the value-added tax rates for electricity, natural gas, and related energy products will return from reduced levels to the standard 21%, and the special electricity tax will also revert to 5%. Although some support measures such as electricity bill subsidies for vulnerable groups will continue, the withdrawal of tax incentives itself is an additional impact on top of high energy prices. The latest report from the Goldman Sachs strategy team indicates that the conflict in the Middle East has led to persistently high energy prices, and is currently driving core inflation higher through energy cost channels. The European Central Bank's biggest concern at the moment is not the energy prices themselves, but the transmission effects to a wider economic area. Olaf Sleijpen, President of the Dutch Central Bank, recently stated that the key to determining the ECB's next policy is whether the energy price shock will continue and further push up core inflation. Currently, there are increasingly visible signs of "second-round effects" in the market. Business transport, manufacturing, and service costs continue to rise, and more and more companies are starting to pass on the energy costs to consumers. Internal documents from the European Central Bank show that market expectations for inflation in 2026 and 2027 have been significantly revised upwards. It is worth noting that on Friday, a blog post from the European Central Bank pointed out that the war in Iran may push up mid-term inflation expectations for Eurozone consumers, which also provides a basis for rate hikes. The post on Friday stated that following the Russia-Ukraine war and previous geopolitical tensions leading to soaring prices in 2022, there is an increasing possibility that households will expect prices to rise even faster, creating a "double blow." Policymakers are particularly concerned about these expectations because they want to prevent the rise in energy costs caused by the war from spreading through wage and corporate pricing mechanisms to broader inflation. Although short-term price expectations have risen significantly, long-term price fluctuations are relatively small. However, the blog post on Friday pointed out, "Looking ahead, consumers often infer mid-term inflation expectations based on short-term price expectations, and they may not have fully felt the impact of inflation on retail prices yet. Therefore, there is indeed a risk of further upward adjustment in mid-term inflation expectations in the future." The economic projections released by the European Central Bank previously showed that if the conflict in the Middle East continues, the Eurozone's inflation rate could rise to above 3.5% this year, and in extreme cases, even close to 5%. French Finance Minister Roland Le Scour tried to appease market sentiment by stating that current inflation is mainly driven by energy prices and, compared to other European countries, "France's inflation remains relatively limited and overall controllable." Europe is facing a challenge of "stagflation" Meanwhile, economic growth in Europe is slowing down. Revised data shows that France's GDP shrank by 0.1% in the first quarter, worsening from the initial "zero growth" estimate. Consumer confidence has also fallen to a three-year low. France's statistics department pointed out that there is a significant increase in households' worries about future income and purchasing power. The overall growth prospects for the Eurozone are also not optimistic. The latest survey shows that the Eurozone's GDP growth rate for 2026 is expected to sharply slow down from 1.4% in 2025 to 0.9%, a downward revision of 0.5 percentage points from previous forecasts. The minutes of the ECB's April meeting showed that the quarterly GDP growth rate in the first quarter had slowed to just 0.1%, halving from 0.2% in the fourth quarter of 2025. Germany's long-term manufacturing slump, combined with a decline in export competitiveness, has made Spain the only "growth champion" among the four major economies, with a GDP forecast of 2.2%. For the European Central Bank, the current situation is becoming increasingly complex. On the one hand, the continuously rising energy prices are forcing the central bank to tighten monetary policy again; on the other hand, rate hikes may further suppress the already weak economic growth. Europe is heavily reliant on energy imports, especially from Middle Eastern crude oil and liquefied natural gas supplies. After the risks of transport through the Strait of Hormuz have increased, Europe has become one of the most vulnerable economies in the global energy shock. The market is concerned that Europe may be gradually entering a phase of "stagflation" similar to the 1970s - a period of stagnant economic growth combined with high inflation. The European Central Bank has clearly stated that the future policy path will depend heavily on changes in the energy market and whether inflation expectations spiral out of control. The energy shock not only raises living costs but is also eroding Europe's industrial competitiveness. The European Central Bank's semi-annual financial stability report warned that rising energy prices would drag down economic growth, leading to a decrease in the tax revenue expected by Eurozone governments when formulating the budget for 2026. At the same time, the increased fiscal expenditure to support households and businesses may expand the fiscal deficit, further lowering bond prices. It is estimated that since the outbreak of the war, the EU's oil and gas import bill has increased by about 6 billion euros, and this figure is still rapidly rising. If oil prices continue to remain high and businesses and consumers begin to have sustained expectations of price increases, the European Central Bank may be forced to take more aggressive tightening measures than the market currently expects. In the post on Friday, the European Central Bank pointed out that although "the overall trend of turning to stagflation is not as clear as it was four years ago," they warned that the current data "only provide a snapshot." For the global market, this means that Europe may be re-entering a "high-interest rate era", and outside of the global AI boom, energy and geopolitical risks are once again becoming the core variables determining global financial markets.