The impact of the Middle East war becomes evident as the Eurozone's March inflation rises rapidly, with price transmission pressures drawing significant attention.

Eurostat’s data released Tuesday showed that, as the Middle East conflict sharply drives up energy prices, the euro area’s inflation rate rose in March from last month’s 1.9% to 2.5%, marking the first time it has surpassed the European Central Bank’s 2% inflation target since last November.

(Source: Eurostat)

It also marks the highest level for euro area inflation since January 2025, and the steepest increase since 2022.

Since fighting reignited in Iran on February 28, Brent crude oil prices have already climbed by 50%, breaking above the $100 per-barrel mark, so almost all of the euro area’s inflation uptick is coming from oil prices. The data show that in March, the euro area’s energy prices rose 4.9% year over year, the first year-over-year increase since February 2025; the February figure was -3.1%.

(Source: Eurostat)

Looking at major regional economies, Germany (2.0%→2.8%) and Spain (2.5%-3.3%) saw the largest increases, and France (1.1%→1.9%) is also rising rapidly, though it did not reach 2%. Italy, meanwhile, remained unexpectedly at 1.5%.

However, the “second-round inflation effect” caused by the rise in energy prices—namely, energy price increases feeding through into the prices of other goods and services—has not yet appeared in this inflation report. Because services inflation has fallen back, the euro area’s core inflation rate even dropped from 2.4% in February to 2.3%.

Of course, if the Middle East conflict continues to push up energy prices, it will only be a matter of time before inflation transmission occurs. Data released by the European Union on Monday showed that euro area consumers’ 12-month inflation expectations rose markedly, and businesses also expect sales prices to jump significantly.

So, European Central Bank policymakers will weigh how to respond to the next round of upward inflation pressure.

In the ECB’s official mid-March economic projections, the ECB set this year’s baseline inflation outlook at 2.6%. In a more extreme scenario, euro area inflation could reach a peak of 6.3% at the beginning of 2027 and average 4.8% for the full year in 2027.

In response, Madis Müller, governor of the Central Bank of Estonia, said Tuesday: “Today we can say that the baseline scenario locked in as of March 11 is very likely to be regarded as an optimistic scenario. If energy prices remain at high levels for a long time, of course we cannot rule out the possibility of interest rate changes as early as April.”

Last week, ECB President Lagarde said in a speech that if inflation deviates significantly from the target level, the policy response must be sufficiently forceful or sustained.

LSEG data show that traders expect the ECB to hike rates three times this year from the current 2% level, with most expecting the next hike at the following meeting (April 30).

Diego Iscaro, head of European economic research at S&P Global Market Intelligence, also noted: “While communication so far has been relatively cautious, there are signs that the rise in energy prices is filtering into inflation expectations, which is likely to prompt the ECB to act as early as April by raising policy rates.

The euro area situation could also emerge in more regions. Joshua Mahony, chief markets analyst at Scope Markets, said Tuesday: “The rapid rise in euro area inflation indicates that second-round pricing pressure is forming—and it has only just started to show itself. What is worth noting is that the energy factor has shifted from being the key force that previously pushed inflation back down to becoming the main driver pushing inflation above the target level.”

He added: “For central bank officials in each country, the next task is to determine whether this change is only a stage-specific factor that can be temporarily ignored or whether it signals a driver that will further push inflation upward in the future.”

(Source: Caixin Global)