Energy costs, reignited by ongoing Middle East tensions, have pushed inflation higher in both of the eurozone's largest economies for August, solidifying investor expectations for another rate increase from the European Central Bank at its upcoming September meeting.

Consumer prices in France accelerated to 2.7% last month, hitting their highest level since May and surpassing market forecasts. Meanwhile, Spain's annual inflation rate climbed to 4.5%, the quickest pace since the start of 2023. Although this figure was marginally below the median estimate from a Bloomberg survey, it remains more than double the ECB's 2% target. Rising energy prices were the common catalyst driving price gains in both nations.

Following the data release, investors have fully priced in a 25-basis-point hike for the September governing council session. This would follow the ECB's initial rate rise in June, its first in nearly three years, and would lift the deposit facility rate from 2.25% to 2.5%. Futures markets also indicate expectations for at least one more hike before spring 2027.

Adding to the intrigue, the minutes from the July policy meeting suggested officials have begun deliberating whether a "mildly restrictive" policy stance is necessary to steer inflation back to target. This has fueled speculation that the terminal rate may ultimately need to surpass 2.5%, a level previously identified by Chief Economist Philip Lane as the upper boundary of the neutral range.

Energy Shock Reignites Price Pressures in France and Spain

Spain's CPI rose 4.5% year-on-year in August, marking its fastest clip since 2023, even as its economic expansion continues to outperform most eurozone peers. In France, the second-largest eurozone economy, inflation ticked up to 2.7% – the highest since May – though this coincides with a significant downward revision to the country's growth data for the first half of 2026.

Energy remains the core driver of inflation in both countries, with the root cause tracing back to the persistent military conflict in the Middle East. To cushion the impact of the Iran war, the Spanish government approved a 5 billion euro ($5.8 billion) aid package in March, including energy tax cuts. While these measures are still in effect, their impact has weakened compared to when they were first introduced.

Inflation data for the entire 21-nation eurozone is scheduled for release next week, with analysts projecting the figure will exceed 3%. Separate monthly data from the European Commission on Friday revealed a significant uptick in consumer expectations for prices over the next 12 months in August. Furthermore, businesses across all sectors reported that their expected selling prices remain above their long-term averages.

September Hike Priced In, Debate Shifts to Restrictive Territory

With the September move fully priced in, market attention is turning to the longer-term trajectory. The July meeting minutes, released on Thursday, showed policymakers questioning whether "mildly restrictive" monetary policy is required to guarantee price stability. This suggests rates could climb beyond the 2.5% threshold, a figure Lane has suggested could represent the top of the neutral range.

Paul Hollingsworth, head of developed markets research at BNP Paribas, noted that the September hike is "almost a done deal," but cautioned that "the path beyond September is broadly uncertain." He indicated the debate on the need for restrictive policy might come to a head at the December meeting.

Officials Signal Vigilance Against Entrenched Inflation

ECB Executive Board member Isabel Schnabel told Bloomberg this week that officials must push borrowing costs higher to curb inflationary pressures emanating from the Iran war and the economy's resilient growth despite numerous headwinds.

Governing Council member Martins Kazaks told Latvian TV3 on Friday: "We must not allow inflation to become entrenched. One way to reduce the risk of it becoming entrenched is to hike rates, and we have already done that once."

Ana Andrade at Bloomberg Economics observed that the sharp rise in Spanish headline inflation in August was driven largely by fuel prices. Although the tax cuts remain in place, their effect is considerably weaker than at the start of the year. She noted that core inflation has only eased slightly and underlying price pressures remain sticky, predicting that harmonized core inflation will stay above 3% for the remainder of the year due to strong wage growth and the economy operating above capacity.

The final justification for the September policy decision will come next week with the release of the eurozone-wide inflation print.