Inflation has truly arrived! Driven by energy prices, Europe's CPI hits the fastest growth rate in four years.

Rising energy prices have pushed overall inflation across the euro area significantly higher, but a contraction in demand has unexpectedly slowed core inflation. The European Central Bank faces an increasingly complex policy stance.

On Tuesday, March 31, data released by Eurostat show that euro area consumer prices rose 2.5% year over year in March, the highest level since January 2025. The month-on-month jump of 1.9 percentage points set the largest increase since 2022.

Meanwhile, excluding food and energy, core inflation unexpectedly fell to 2.3%, below the 2.4% expected by the market, and services inflation also declined in parallel.

After the data was released, ECB officials spoke in succession, sending more hawkish policy signals.

Estonia’s central bank governorMadis Muller said that the baseline scenario, which had been set with March 11 as the cutoff date, “can now only be viewed as an optimistic scenario,” adding explicitly that “if energy prices remain at a high level for the long term, the possibility of adjusting interest rates as early as April cannot be ruled out.”

Slovakia’s central bank governorPeter Kazimir also warned that, “The longer the Iran war lasts and the greater the damage, the higher the inflation risk; we therefore need to respond earlier and more decisively.”

Energy-driven inflation trends, with clear divergence in country data

The main driving force behind the upward inflation trend this round comes from energy.

Goldman Sachs data show that in March, euro area energy inflation rose to 4.9%, the main factor behind the 2.52% year-on-year increase in the overall Harmonised Index of Consumer Prices (HICP).

By country, inflation performance in each member state in March clearly diverged.

Germany and Spain, based on figures previously released, saw inflation rise to 2.8% and 3.3%, respectively, with a particularly pronounced acceleration; France’s inflation picked up but remained below 2%; Italy, unexpectedly, held steady at 1.5% unchanged, showing no signs of warming.

In its analysis, Goldman Sachs noted that services inflation fell to 3.23%, partly due to the base effect from the drop in the subcategory for tourism and hotels related to the Italian Olympics.

Non-energy industrial goods inflation fell to 0.47%, below the firm’s forecast. Using a seasonally adjusted month-on-month basis, core inflation recorded only 0.08% in March, a sharp contraction from 0.33% in February, indicating that underlying pricing pressure has weakened somewhat in the near term.

Uncertainty looms ahead; the ECB baseline scenario may already be outdated

The ongoing spread of conflict in the Middle East has put the ECB’s earlier policy outlook to a severe test.

The ECB previously expected the inflation average for this year to be 2.6%, but as oil and natural gas prices remain at high levels, the credibility of this forecast is declining. It is understood that in extreme scenarios, the inflation increase could peak as high as 6.3% in 2027.

Goldman Sachs forecasts that euro area core inflation will rise to a peak of 2.5% in the third quarter of 2026 and then gradually fall, reaching 2.1% by the end of 2027; overall inflation is expected to average 2.9% in 2026, with a second-quarter peak that may touch 3.2%, before falling back to 2.0% in 2027.

The ECB said it will not allow a repeat of the inflation runaway scenario after the Russia-Ukraine conflict in 2022, emphasizing that it will act quickly and decisively when necessary.

At present, the ECB’s focus is on preventing second-round effects, including excessive wage growth and firms’ pass-through behavior, while also closely monitoring how price transmission chains for fertilizers, food, and others affect households’ inflation expectations.

Central bank officials across countries speak

ECB officials spoke in succession, releasing more hawkish policy signals.

Croatia’s central bank governor Boris Vujcic said that expectations for an acceleration in inflation “are consistent with the earlier judgment”; Italy’s central bank governor Fabio Panetta emphasized that, “closely monitoring expectations and preventing a wage-price spiral is crucial, while also ensuring that monetary policy actions remain appropriately sized.”

Bulgaria’s central bank governor Dimitar Radev, from a longer-cycle perspective, issued a warning, noting that the inflation shocks of the past have left a “lasting imprint” in European consumers’ mindset. “Factors previously seen as external shocks, are now directly being transmitted to inflation expectations, energy prices, financing conditions, and overall confidence.”

In remarks he made on Tuesday, he said that the risks to the inflation outlook are not only “high,” but also “asymmetric, closely linked to the trajectory of geopolitical developments.”

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