Emeritus Professor Joe Nellis is economic adviser at MHA, the accountancy and advisory firm.
Eurozone inflation rose to 3.2% in May as pressure builds on the European Central Bank to act now to combat rising prices. Despite efforts to control it, underlying price pressures remain strong, with service inflation and wage growth persisting, businesses passing on costs, and global instability driving up energy and transport costs. These factors further strain supply chains across Europe.
With this uptick in inflation, the ECB is increasingly likely to raise interest rates by 0.25 percentage points next week. This marks a shift from earlier expectations that the ECB might ease policy later this year to reignite the sluggish Eurozone economy.
While inflationary pressures are growing across the global economy, the ECB faces a particularly acute challenge. Policymakers must now balance rising inflation — which remains well above its official 2% target — against an already fragile economic expansion. France recorded a 0.1% contraction in GDP in the first quarter, while Germany — the Eurozone’s largest economy — grew by only 0.3%, underscoring the weakness persisting across the region.
A rise in interest rates of just 0.25 percentage points would normally attract little attention: 2.25% is still historically low. But the fact that even a small increase is causing concern about the Eurozone’s outlook says a great deal about the economy’s underlying structural problems.
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. Governments with large debt burdens will also face higher borrowing costs at a time when public finances are already under strain.
Yet leaving inflation unchecked brings its own dangers, particularly if higher prices become more deeply embedded across the economy. The ECB is expected to raise rates next week, but looking further ahead is difficult. The future of monetary policy in the economic bloc is unpredictable right now, and highly dependent on developments in the Middle East.
Savvas Klitou, Regional Managing Partner, Baker Tilly South East Europe commented:
From a Cyprus perspective, the implications of higher interest rates are particularly significant. The economy remains sensitive to external shocks, energy price volatility, and tourism‑related dynamics. Inflation is projected to reach approximately 3.6%, reflecting renewed cost pressures. Higher borrowing costs are increasingly passing through to households and businesses, particularly given the prevalence of variable‑rate lending, elevating mortgage burdens and constraining consumption. Consequently, investment activity may soften, testing growth momentum and underscoring the importance of sustained fiscal discipline and structural reform.
