Eurozone inflation surges; ECB to hike in April
Eurozone inflation jumped in March to 2.5% y/y from 1.9% in February, in line with our forecast but a touch below consensus (2.6%). Core inflation in contrast moderated to 2.3%, in line with our forecast but also below consensus (2.4%). The rise was driven by a surge in petrol prices, as the rise in oil prices passed through to pump prices. This caused overall energy inflation to swing from a drag of -3.1% y/y in February to a 4.9% rise in March. Other categories of inflation were however comparatively muted, with food (2.3%), goods (0.5%), and services inflation (3.2%) all moderating. All of this reflects pre-Iran conflict inflation dynamics and we are likely to see a renewed pickup in these categories as the year progresses.
Inflation to peak at over 3% in the coming months
The March rise in inflation is likely the beginning of a sustained pickup in inflation over the coming months. Our base case – which sees severe energy disruptions lasting until the end of May – is for a further jump in inflation to 2.9% in April, and above 3% in May. While oil prices pass through relatively quickly to inflation, the rise in natural gas prices and spillovers to other categories (such as energy intensive goods and services) will take somewhat longer. An additional source of upward pressure is likely to eventually come from food prices, which will be impacted by the rise in fertiliser costs. However, this is likely to take time given the current supply abundance of various food commodities and given that feriliser is typically bought well in advance of growing seasons.
ECB to hike pre-emptively already in April
We expect the ECB to raise rates already at the April and June Governing Council meetings, taking the deposit rate to 2.50%, in order to pre-empt any de-anchoring of inflation expectations. We have more conviction in the April hike than the June hike, given the ongoing uncertainty of the conflict. It could well be the case that with the conflict ending and energy prices quickly normalising, the Governing Council gains enough visibility on the inflation outlook that it holds off from hiking in June. Policy tightening would be aimed at preventing second round effects from the energy shock spilling over to the labour market specifically – something we saw in the aftermath of the 2022 energy shock, which coincided with a relatively tight labour market and therefore encouraged workers to demand pay rises to compensate for the real income shock. This ultimately fed back into services inflation, setting off a short-lived wage-price spiral. The combination of a smaller initial inflation shock, pre-emptive ECB tightening and a higher starting point for interest rates, as well as a looser labour market, should prevent such a dynamic from taking hold this time around. With that said, we do expect some limited second round effects that will offset some of the drag from falling energy prices that we expect in 2027. See our Global Monthly here for more.