European inflation is back above 3%. Higher interest rates are likely

Key Points:

• Eurozone headline inflation rose to 3.3% in August from 2.9% in July, driven primarily by a sharp increase in energy prices, with energy inflation jumping to 14.3% amid disruptions linked to the Iran war and the Strait of Hormuz blockade.
• Core inflation, which excludes volatile items like energy and food, slightly decreased to 2.4%, indicating some underlying price stability despite overall inflation pressures.
• The European Central Bank (ECB) is widely expected to raise interest rates by 25 basis points to 2.5% at its September 10 meeting to combat rising inflation, marking a continuation of tightening monetary policy initiated in June.
• Higher interest rates pose risks to heavily indebted households and businesses, particularly small and medium-sized enterprises (SMEs), which may face postponed or abandoned investment plans due to increased borrowing costs.
• The ECB faces a challenging balance between curbing inflation and avoiding excessive economic slowdown, as sustained inflation could become structural and impact wages and services prices.