Inflation in the euro area rose sharply in August. Surging energy prices in particular are currently driving inflation to its highest level in almost three years. In Spain, the harmonised inflation rate stands at 4.5 per cent, significantly above the European average. This is putting increasing pressure on the European Central Bank to raise interest rates again in September.
Spain Expat Press Editorial Team
by Marlon Gallego Bosbach
Inflation in the euro area rose sharply in August. According to preliminary data from Eurostat, the annual inflation rate increased from 2.9 per cent in July to 3.3 per cent in August. This puts inflation once again significantly above the European Central Bank’s (ECB) target of 2 per cent over the medium term.
Energy prices are primarily responsible for the latest surge in inflation. In August, they were 14.3 per cent higher than a year earlier, compared with an increase of 10.3 per cent in July. At the same time, other key components of inflation remained considerably more moderate. Inflation in services slowed from 3.3 to 3.0 per cent, while prices for non-energy industrial goods rose by 1.2 per cent, and food, alcohol and tobacco also increased by 1.2 per cent.
Spain faces even greater price pressures
The development in Spain is likely to attract particular attention. While inflation in the euro area stands at 3.3 per cent, Spain’s harmonised consumer price index (HICP) reached 4.5 per cent in August.
According to preliminary data from Spain’s National Statistics Institute (INE), national consumer price inflation stood at 4.3 per cent, seven-tenths of a percentage point higher than in July. Core inflation, which excludes energy and unprocessed food, edged down to 2.9 per cent. The harmonised index, which allows for direct comparisons with other euro area countries, rose to 4.5 per cent.
This puts Spain more than one percentage point above the euro area average. The development is particularly significant because Spain was already among the larger economies with comparatively high inflation this summer. In July, Spain’s harmonised inflation rate stood at 3.9 per cent. Over the course of a single month, the gap between Spain and the euro area has therefore widened further.
Energy crisis drives prices higher once again
The latest surge in inflation is largely driven by geopolitical factors. Energy prices have risen sharply as a result of ongoing tensions and the conflict in the Middle East. Developments in the international oil and gas markets, in particular, are increasingly feeding through into consumer prices across Europe.
For households, this initially means higher costs for fuel and energy. However, the impact does not stop at the petrol station or the energy bill. Rising energy prices also increase the cost of transport, production and logistics. Companies subsequently pass on some of these additional costs to their customers through higher prices..
This is precisely where the greatest risk for the ECB lies: what initially appears to be an external energy shock could develop into broader and more persistent inflationary pressure.
The good news: Core inflation remains relatively under control
Despite the significant rise in headline inflation, there is an important difference compared with previous inflation shocks. So-called core inflation remains considerably more stable. In the euro area, it even edged down slightly to 2.4 per cent in August. In Spain, national core inflation also fell slightly to 2.9 per cent, according to preliminary data from the INE.
This suggests that the current surge in prices is still largely being driven by energy costs and has so far not fully spread across the wider economy.
This is crucial for the ECB. The central bank can neither make oil nor natural gas cheaper. It can, however, try to prevent the energy shock from translating into persistently higher wages, prices and inflation expectations.
ECB poised for another interest rate hike in September
The new inflation data are therefore increasing pressure on the European Central Bank. The ECB most recently kept its deposit rate at 2.25 per cent, postponing a decision on further rate moves to the coming months. As early as July, a possible interest rate hike in September was expected to be back on the agenda.
Financial markets are now largely expecting a 25-basis-point increase to 2.50 per cent at the ECB’s September meeting. Reports suggest that, in light of the latest inflation data, such an increase is now almost fully priced in by the markets.
The situation is nevertheless a challenging one for the ECB. At the same time, economic momentum across the euro area remains relatively weak. The central bank recently lowered its growth forecast for 2026 to just 0.8 per cent.
The central bank is therefore facing a classic dilemma: high inflation calls for higher interest rates, while a weak economy argues against them.
What does this mean for Spain?
The situation could be particularly challenging for Spain. Although the Spanish economy remains relatively dynamic, high inflation is putting pressure on household purchasing power. As energy, transport and everyday services become more expensive, consumers have less money available for other spending.
A particularly challenging aspect is that Spain does not control its own monetary policy. The key interest rate is set by the ECB for the entire euro area. This means that even if the Spanish government or the Spanish economy were to require lower interest rates, the Banco de España cannot independently cut the key interest rate.
Spain’s currently higher inflation could even have the opposite effect: the ECB may need to keep interest rates higher for longer, even though not all euro area countries are experiencing the same level of inflationary pressure.
Mortgages and loans could become more expensive again
The potential consequences could be felt immediately by Spanish households. Another interest rate hike would primarily affect borrowing costs, with variable-rate mortgages and new loans particularly exposed. By the end of August, the Euribor had already risen significantly again, briefly surpassing the 3 per cent mark.
Should the ECB actually raise interest rates to 2.50 per cent, borrowing costs could rise further. For households with variable-rate mortgages, this could mean higher monthly repayments. Businesses, too, would face additional costs when relying on credit financing.
On the other hand, savers generally benefit from higher interest rates, provided that banks pass on their increased refinancing costs to customers.
Not yet another inflation scenario like 2022
Despite the alarming headlines, the current situation should not be equated with the major inflation wave of 2022. The key difference is core inflation. While the previous price shock spread much more broadly across the economy, the current increase is being driven primarily by the energy sector.
The development in services is also an important indicator: inflation in this sector fell from 3.3 to 3.0 per cent in August. This suggests that price pressures outside the energy sector have not yet accelerated to the same extent.
The key question, therefore, is not simply how high oil prices are today, but how long energy prices will remain at these levels.
What happens next?
Over the coming months, the development of energy prices will be the decisive factor. If oil and gas prices fall again, inflation could ease significantly next year. Part of the current price increase would then drop out of the annual inflation rate due to so-called base effects.
If energy prices remain high for an extended period, pressure on the ECB could increase further. In that case, a rate hike in September may not be the last step.
This is precisely the risk that markets are watching particularly closely at present. The ECB could potentially adopt a wait-and-see approach following a possible rate hike in September. However, if energy prices continue to rise and inflation feeds more strongly into wages and services, further interest rate increases could become necessary.
The development is particularly significant for Spain
The figures from Madrid make it clear that Spain is currently facing greater inflationary pressure than the euro area as a whole. Harmonised inflation in Spain stands at 4.5 per cent, compared with 3.3 per cent across the euro area – a gap of 1.2 percentage points. At the same time, Spain’s core inflation rate of 2.9 per cent is considerably closer to the European level.
This suggests that a significant part of Spain’s current inflation problem is also linked to energy and other volatile components. Nevertheless, the impact on consumers is real: higher prices for transport, energy and everyday essentials are reducing purchasing power.
This makes the balancing act increasingly difficult for the ECB. It must prevent the current energy crisis from fuelling persistent inflation without simultaneously choking off the already fragile economic recovery.
The most likely short-term development is therefore another interest rate hike in September. The key question after that will be whether the energy shock subsides again – or whether Europe is heading for a prolonged period of high inflation and higher interest rates.
