Inflation jumps across euro zone, raising pressure on ECB to hike

Inflation rose far quicker than expected in some of the euro zone's biggest economies this month due to the energy-price shock of the Iran war, increasing pressure on the European Central ‌Bank to raise interest rates again. The ECB has lifted rates twice this year to prevent rapid price growth from getting embedded, and investors have sharply raised rate hike bets in the past few weeks as natural gas, petrol and diesel prices have all soared.

France's harmonized inflation rate was 3.4% year-on-year in September, up from 2.6% in August, while in Italy it ‌jumped to 4.1% from August's 3.2%, all above the ECB's 2% target, data showed on Wednesday. German inflation accelerated slightly more than expected in September, rising to 3.3% year-on-year ‌from 2.9% in the month before.

Core inflation, which excludes the volatile prices of energy and food, remained unchanged for the third consecutive month at 2.4%. In Spain, the inflation rate rose to 5.0% in September from 4.6% in August, data showed on Tuesday.

Energy inflation appears to have surprised on the upside in all countries that have reported so far, as has food inflation, although much more modestly, Mariana Monteiro from J.P. Morgan said. The national ⁠data comes ​ahead of the euro zone inflation release on ⁠Friday. Inflation in the bloc is expected to come in at 3.6% in September, up from 3.2% in the previous month, according to economists polled by Reuters.

HIGHER THAN THE ECB EXPECTED The ECB had expected ⁠inflation to accelerate from 3.3% in the third quarter to 3.6% in the final three months of the year, but economists say the actual peak is likely to be closer to 4%, given ​sky-high energy costs.

Markets therefore expect another four interest rate hikes over the next year, on top of two moves already made this past summer. "With very few ⁠signs of a resolution of tensions in the Middle East on the horizon and winter approaching, a correction in energy prices is unlikely any time soon," Rory Fennessy, senior European economist at Oxford Economics, said.

Under its "adverse" scenario, ⁠the ​ECB sees inflation at 4.0% in both the fourth quarter of this year and the first three months of 2027, and economists say current energy prices are more closely aligned with this scenario than its baseline. Furthermore, the dollar's recent strength will exacerbate Europe's inflation troubles, as key commodities are priced in dollars and the exchange-rate impact makes ⁠energy even more expensive in local currencies.

Because this year's inflation surge has yet to generate dangerous second-round effects across the euro zone, a moderate policy response from the European ⁠Central Bank remains appropriate, ECB chief Christine Lagarde ⁠said on Monday. Although the indirect effects of higher energy costs are beginning to feed through, this is unlikely to tip the balance for the ECB, Jack Allen-Reynolds, chief euro zone economist at Capital Economics, said.

Core inflation has not yet moved up notably this ‌year, but the renewed spike in ‌energy prices means core inflation could rise into early 2027, Fennessy warned.