Eurozone inflation reaches record high of 7.5%

Eurozone inflation, including the core rate, reached a record high in March, the European Union’s statistical office said today (April 1).

In March the headline rate of harmonised price index of consumer prices rose year on year by 7.5%, up from 5.9% in February. The European Central Bank’s inflation target is 2% over the medium term.

Additionally, core inflation excluding energy, food, alcohol and tobacco prices rose by 3%, up from 2.7% in February. Non-energy industrial goods prices increased by 3.4%, and services by 2.7%.

All of these indicators were considerably above the ECB’s target. The effects of ending restrictions imposed due to the Covid-19 pandemic are likely to be one factor driving inflation higher. Supply-chain bottlenecks could ease goods prices, but the end of Covid-19 restrictions are likely to boost service prices.

Energy remained the main component pushing prices up across the region. These increased by 44.7%, up from 32% in February. This key factor in the headline reading had been boosting prices since the third quarter of 2021, but the sharp acceleration in the inflationary process experienced last month is likely to be connected to the Russian invasion of Ukraine.

The war started on February 24, immediately contributing to sharp increases in oil and gas prices. According to official data, Russia is the EU’s main gas supplier, providing around 46% of gas imports, and a key oil exporter, delivering around 25% of the continent’s imports.

European sanctions on the Russian economy have so far exempted the import of these key raw materials. However, the US and the UK have banned Russian oil imports. If the EU were to join them, the impact on energy prices could be considerably higher.

Up until the beginning of the war, ECB officials had stressed high inflation was temporary. ECB president Christine Lagarde and chief economist Philip Lane said this was a process largely driven by energy prices and supply chain bottlenecks derived from the reopening of the global economy after the demand/supply mismatches created by the pandemic.

However, Russia’s aggression has dramatically changed this outlook. On March 10, the ECB revised up its inflation projections, which is now expected to average 5.1% in 2022, 2.1% in 2023 and 1.9% in 2024. Nonetheless, ECB staff calculations took into account a time frame that did not include the war in its assessment.

“The pick-up in inflation was broad-based across countries and product categories, with inflation accelerating sharply in all the biggest bloc’s economies,” says Maddalena Martini, senior economist with Oxford Economics.

Inflation rose by 11.9% in the Netherlands, 9.8% in Spain, 7.6% in Germany and 7% in Italy.

Higher energy prices reflect “the impact on fuel costs of the rise in oil prices since the Ukraine war began, as well as the lagged effects of increased gas prices in previous months,” says Jack Allen-Reynolds, senior Europe economist with Capital Economics. “While fuel inflation may have peaked, the rise in wholesale gas prices since the war began won’t yet have fully fed through to consumer prices, so energy inflation looks set to remain very high.”

“Before the pandemic, the highest rate of core inflation since 1999 was 2.5% in early 2002,” says Allen-Reynolds. “Both services and core goods inflation rose on the month. And looking ahead, all of the latest survey evidence suggests that price pressures remain extremely strong, so there is a good chance that core inflation will keep rising.”

“March’s outturn left average inflation in Q1 at 6.2%, more than half a percentage point higher than the ECB forecast just three weeks ago when it already had the data for January and the flash estimate for February,” says Allen-Reynolds. “We now forecast that headline inflation will average around 6.5% this year, and the risks lie to the upside.”

Sharp policy change?

After its latest policy meeting on March 10, the ECB governing council decided to accelerate the end of its asset purchase programmes. It confirmed the end of net purchases under the Pandemic Emergency Purchase Programme (PEPP), and brought forward the possibility of halting purchases under the Asset Purchase Programme (APP).

In order to offset the impact of halting PEPP purchases, the ECB increased operations under the APP from €20 billion to €40 billion in April. These are scheduled to decline to €30 billion in May and €20 billion in June. The ECB said if the outlook is consistent with reaching 2% inflation over the medium term, it would completely halt asset purchases in July.

The governing council modified its forward guidance indicating it planned to wait longer before it starts increasing rates after halting asset purchases.

But this new record inflation reading makes it “increasingly likely that the ECB will accelerate its plans to tighten monetary policy”, says Andrew Kenningham, chief Europe economist with Capital Economics. “We now think it will end net asset purchases in June – ie earlier than the Q3 date which the ECB targeted in March. And we think it will make three 25bp rate hikes later this year followed by five more in 2023.”