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Euro zone inflation hits record 8.6% as the ECB prepares for its first rate hike in 11 years

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Eurozone inflation surged to a record high of 8.6% in June, racing ahead of expectations once again and adding pressure on the European Central Bank to step up its fight against spiraling prices, flash Eurostat data showed on Friday, according to Politico. 

A Reuters poll of analysts had pointed to a record 8.4% jump in June, up from 8.1% in May.

Scorching inflation continues to be primarily driven by energy prices, which were up 41.9% in June compared with 39.1% in May. That’s followed by food, alcohol and tobacco prices, which were up 8.9% in June compared with 7.5% in the previous month.

Core inflation, which strips out volatile components and is seen as a good indicator for underlying price pressures, eased slightly to 3.7% in June from 3.8% in May.

Among member states, the Baltics remain the hardest hit, with inflation hitting 22% in Estonia, 20.5% in Lithuania and 19% in Latvia. The lowest inflation rates were recorded in Malta (6.1%) and France (6.5%).

The fresh upside surprise in inflation may ratchet up ECB rate hike expectations.  The ECB has been signaling that it will raise interest rates by 25 basis points in July, followed by another, possibly larger move in September.

Friday is also first day the ECB no longer adds bonds to its balance sheet, leaving its total holdings just short of €5 trillion, or 40% of eurozone GDP. However, for now it’ll continue to reinvest maturing bonds bought under its various programs.

The ECB will also start to exercise flexibility reinvesting proceeds from bonds bought under the pandemic program to help contain difference in borrowing costs between eurozone member states. In practice, this means that the ECB could buy an Italian bond using the cash from a maturing German bond.

The move was prompted by the recent bond market rout that sparked fears the sovereign debt crisis could return with a vengeance. Since flexible reinvestments are not seen as sufficient to thwart a sovereign debt crisis, the ECB also pledged to design a new to limit so-called bond spreads, or the difference in bond yields between member states.

The risks of a renewed debt crisis is just one headwind the ECB is facing. There are also mounting concerns that the repercussions from the Ukraine war on the eurozone’s doorsteps could push the currency union into a recession.