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Euro zone inflation rose to 2.6% for the first time this year, a worrying sign for investors hoping the ECB will cut interest rates aggressively this year.
Consumer price inflation in the single currency area in the year to May rose to 2.4 percent from the previous month, slightly above the level forecast by economists in a Reuters poll.
Core inflation, which excludes energy and food prices and is a gauge of underlying price pressures, accelerated to 2.9% from 2.7%.
Until this month, euro zone inflation had been falling modestly towards the ECB's 2% target for the year, and policymakers had clearly signalled they planned to start cutting interest rates from a record 4% next week.
German 10-year bond yields, a gauge of euro zone borrowing costs, jumped to 2.7 percent following Friday's data, the highest level in more than six months.
The ECB is still widely expected to cut rates next week, which would make it the first major central bank to ease monetary policy since the biggest inflation rise in a generation began three years ago.
Some of the more dovish members of the ECB's rate-setting governing council downplayed the significance of May's inflation rise, with Bank of Italy Governor Fabio Panetta saying it was “neither good nor bad” and Portugal's Bank Governor Mario Centeno saying it was “not a big deviation from expectations” and would not prevent the ECB from starting to cut rates.
But with price pressures rising again this month and the euro zone economy returning to growth in the first quarter, investors are expecting the ECB to take a more cautious approach to cutting interest rates for the rest of the year.
Some policymakers have warned that rising inflation makes it unlikely that the ECB will deliver a second rate cut in July, with markets pricing in two to three quarter-percentage-point cuts this year.
Jack Allen Reynolds, an economist at Capital Economics, said the jump in euro zone inflation “is unlikely to stop the ECB from cutting rates next week, but further cuts in July seem unlikely.”
ECB chief economist Philip Lane told the Financial Times earlier this month that “barring any major surprises” the ECB was likely to lift the highest level of restrictions when it meets in Frankfurt next week.
He said the pace of further rate cuts would depend on underlying inflation trends and demand levels, and warned that they would likely be “unsteady and gradual.”
Eurozone inflation rose to 0.3% in May as rising energy prices turned positive for the first time in more than a year.
The ECB expects wage growth in the euro zone to slow from recent record highs and for companies to absorb higher labor costs by squeezing profit margins rather than passing them on to consumers in the form of higher prices.
This will be crucial in determining how quickly inflation in the labor-intensive services sector will fall this year.Euro zone services inflation rose to a seven-month high of 4.1% in May, from 3.7% the previous month.
But some economists see temporary factors behind the recent rise in services inflation, including the early timing of Easter this year and the deflationary effect of discounted public transport tickets in Germany fading.
“Rising services price inflation is not a welcome development,” Diego Iscaro, an economist at S&P Global Market Intelligence, said, adding that he would wait for more detailed data to show “whether the removal of German transport subsidies is the main cause or whether there are other factors pushing up services prices.”
There are signs that consumers remain cautious even as wages have risen faster than inflation this year, giving them more purchasing power.Separate data released on Friday showed German retail sales fell 1.2% in April from the previous month, while French retail sales fell 0.8% in the same period.
