Has the eurozone finally been beaten, or is the battle far from over?

For a short period this summer, it looked like the eurozone was finally making progress against inflation. However, renewed tensions in the Middle East have raised concerns that this progress could be temporary.

On the positive side, Eurostat's final figures, released in mid-July, showed annual inflation in the euro area fell from 3.2% in May to 2.8% in June, the first decline since inflation started rising again in January. Core inflation, which excludes volatile items such as energy, food, alcohol and tobacco, also fell from 2.6% to 2.4%. Energy inflation eased from 10.8% to 8.5%, services inflation slowed, and 22 of the EU's 27 member states recorded lower inflation rates.

Despite this improvement, inflation remains above the European Central Bank's (ECB) 2% target. Much of the earlier increase was caused by the renewed US-Iran conflict in late February, which pushed up oil prices and disrupted energy markets. In response, the ECB raised its deposit rate by 25 basis points to 2.25% on 11 June to prevent higher energy prices from causing longer-term inflation. At the same time, it revised its 2026 inflation forecast up to 3.0% and cut its growth forecast to just 0.8%, reflecting concerns about slower economic growth alongside persistent inflation.

At its latest meeting, the ECB left interest rates unchanged, keeping the deposit rate at 2.25%, the main refinancing rate at 2.4%, and the marginal lending facility at 2.65%. This decision was widely expected, as policymakers preferred to wait for updated economic forecasts in September before deciding whether further action would be needed.

ECB President Christine Lagarde has also made it clear that the fight against inflation is not over. She has avoided giving any indication of future rate decisions, instead saying that the ECB will continue to assess incoming economic data at each meeting. Current ECB projections suggest inflation may not return to the 2% target until late 2027.

Recent developments have reinforced these concerns. Brent crude oil prices rose above $100 per barrel after Iran-backed Houthi rebels reportedly targeted Saudi oil tankers near the Bab al-Mandeb Strait, raising fears of further disruptions to global energy supplies. As a result, many economists now expect the ECB to raise interest rates again in September, potentially increasing the deposit rate to 2.5%.

There are still some encouraging signs. Business confidence has improved, with Germany's ZEW Economic Sentiment Index rising from 10.5 in June to 26.3 in July. Confidence also improved across the wider eurozone, suggesting businesses expect economic conditions to strengthen despite ongoing inflation risks.

Overall, inflation is moving in the right direction, but the eurozone has not fully overcome the problem. Falling inflation in June was a positive development, but renewed energy price pressures and continuing geopolitical tensions mean inflation remains a significant risk. The ECB is therefore likely to keep interest rates high and may raise them further if inflationary pressures persist.