Inflation Arrives! Energy Prices Propel Eurozone CPI to Fastest Growth in Four Years

Soaring energy prices have driven Eurozone headline inflation significantly higher, but contracting demand led to an unexpected slowdown in core inflation, complicating the European Central Bank's policy direction.

On Tuesday, March 31, Eurostat data showed that Eurozone consumer prices rose by 2.5% year-on-year in March, the highest level since January 2025. This represents a jump of 1.9 percentage points from the previous month, the largest increase since 2022.

Core inflation, excluding food and energy, unexpectedly fell to 2.3%, below the market expectation of 2.4%, with services inflation also retreating.

Following the data release, ECB officials issued increasingly hawkish policy signals.

Governor of the Bank of Estonia Madis Muller stated that the baseline scenario previously set with a March 11 cutoff "can now likely only be seen as an optimistic scenario," noting that "if energy prices remain high for a long time, the possibility of adjusting interest rates as early as April cannot be ruled out."

Governor of the National Bank of Slovakia Peter Kazimir also warned that "the longer the war in Iran lasts and the more destructive it becomes, the higher the inflation risks, and the earlier and more decisively we must respond."

Energy Dominates Inflation Trends; Significant Divergence Across Nations

The primary driver of the current inflation surge is energy.

Goldman Sachs data shows that Eurozone energy inflation rose to 4.9% in March, a key factor driving the overall Harmonised Index of Consumer Prices (HICP) up by 2.52% year-on-year.

On a country-by-country basis, inflation performance in March varied significantly among member states.

Germany and Spain previously released data showing inflation rising to 2.8% and 3.3% respectively, with a notable acceleration; France's inflation accelerated but remained below 2%; while Italy unexpectedly held steady at 1.5%, showing no signs of warming.

Goldman Sachs noted in its analysis that the decline in services inflation to 3.23% was partly due to base effects from a pullback in Olympic-related tourism and hospitality components in Italy.

Non-energy industrial goods inflation fell to 0.47%, below the firm's forecast. On a seasonally adjusted month-on-month basis, core inflation recorded just 0.08% in March, a significant narrowing from 0.33% in February, indicating a short-term easing of endogenous price pressures.

Outlook Fraught with Uncertainty; ECB's Baseline Scenario May Be Outdated

The continued spread of conflict in the Middle East is posing a severe challenge to the ECB's previous policy forecasts.

The ECB had previously projected an average inflation rate of 2.6% for this year, but the credibility of this forecast is declining as oil and gas prices remain high. It is reported that in an extreme scenario, inflation could peak at 6.3% by 2027.

Goldman Sachs forecasts that Eurozone core inflation will peak at 2.5% in the third quarter of 2026 before gradually declining to 2.1% by the end of 2027. Headline inflation is projected to average 2.9% in 2026, with a peak of 3.2% in the second quarter, falling to 2.0% in 2027.

The ECB stated that it will not allow a repeat of the runaway inflation seen after the 2022 Russia-Ukraine conflict and emphasized that it will act quickly and decisively when necessary.

Currently, the ECB is focused on preventing second-round effects, including excessive wage hikes and corporate follow-on price increases, while closely monitoring the impact of price transmission chains for items like fertilizers and food on household inflation expectations.

Statements from Central Bank Officials

ECB officials have issued increasingly hawkish policy signals.

Boris Vujcic, Governor of the Croatian National Bank stated that the expected acceleration of inflation "aligns with previous assessments"; Fabio Panetta, Governor of the Bank of Italy emphasized that "closely monitoring expectations and preventing wage-price spirals is crucial, while ensuring that monetary policy actions remain appropriate."

Dimitar Radev, Governor of the Bulgarian National Bank issued a warning from a longer-term perspective, noting that past inflation shocks have left a "lasting imprint" on European consumer psychology. He stated that "factors previously considered external shocks are now transmitting directly to inflation expectations, energy prices, financing conditions, and overall confidence."

In a speech on Tuesday, he pointed out that risks to the inflation outlook are "not only high" but also "asymmetric and closely linked to geopolitical developments."