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

Why does core inflation slow down despite soaring energy prices?

Energy prices soaring have driven overall inflation in the Eurozone sharply higher, but demand contraction has unexpectedly eased core inflation, making the European Central Bank’s policy stance increasingly complex.

On Tuesday, March 31, the EU Statistical Office announced that the euro area’s consumer prices in March rose by 2.5% year-on-year, reaching the highest level since January 2025.
Compared to the previous month, prices jumped by 1.9 percentage points, the largest increase since 2022.

Excluding food and energy, core inflation unexpectedly fell back to 2.3%, below market expectations of 2.4%, and service sector inflation also declined.

After the data was released, ECB officials spoke successively, signaling a more hawkish policy stance.

Madis Muller, Governor of the Estonian Central Bank, said that the baseline scenario set with a deadline of March 11 “can now only be regarded as optimistic,” and explicitly pointed out that “if energy prices remain high for a long time, there is a possibility of adjusting interest rates as early as April.”

Peter Kazimir, Governor of the Slovak Central Bank, also warned that “the longer and more destructive the Iran war lasts, the higher the inflation risk, and we need to respond earlier and more decisively.”

Energy-led inflation trend, with clear divergence among countries

The main driver of this inflation uptrend comes from energy.

Goldman Sachs data shows that energy inflation in the euro area rose to 4.9% in March, which is the main factor pushing the overall harmonized consumer price index (HICP) year-on-year increase of 2.52%.

Looking at individual countries, inflation in March varied significantly.

Germany and Spain previously reported inflation rates of 2.8% and 3.3%, respectively, showing a more pronounced acceleration; France’s inflation accelerated but remained below 2%; Italy unexpectedly held steady at 1.5%, with no signs of heating up.

Goldman Sachs analysis pointed out that service sector inflation fell to 3.23%, partly due to the base effect from tourism and hotel industry related to the Italian Olympics.

Inflation for non-energy industrial goods fell to 0.47%, below the bank’s forecast. From seasonally adjusted month-on-month data, core inflation in March was only 0.08%, a significant narrowing from 0.33% in February, indicating that endogenous price pressures have weakened in the short term.

Uncertain outlook, ECB’s baseline scenario may be outdated

The ongoing Middle East conflict continues to escalate, posing a severe test to the ECB’s previous policy forecasts.

The ECB previously projected an average inflation of 2.6% this year, but with oil and natural gas prices remaining high, this forecast’s credibility is declining. It is reported that, under extreme scenarios, inflation could peak at 6.3% in 2027.

Goldman Sachs predicts that euro area core inflation will peak at 2.5% in the third quarter of 2026 and then gradually decline, reaching 2.1% by the end of 2027; overall inflation is expected to have an average of 2.9% in 2026, with a peak possibly hitting 3.2% in the second quarter, and falling back to 2.0% in 2027.

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

Currently, the ECB’s focus is on preventing secondary effects, including excessive wage increases and corporate pass-through behaviors, while closely monitoring how price transmission chains in fertilizers, food, and other sectors influence household inflation expectations.

Statements from national central bank officials

ECB officials have successively spoken, signaling a more hawkish policy stance.

Boris Vujcic, Governor of the Croatian Central Bank, said that the expectation of accelerating inflation “aligns with previous judgments”; Fabio Panetta, Governor of the Italian Central Bank, emphasized that “closely monitoring expectations and preventing wage-price spirals is crucial, while ensuring that monetary policy actions remain moderate.”

Dimitar Radev, Governor of the Bulgarian Central Bank, issued a warning from a longer-term perspective, noting that past inflation shocks have left a “lasting imprint” on European consumers’ psychology, and that “factors previously seen as external shocks, such as energy prices and geopolitical risks, are now directly influencing inflation expectations, energy prices, financing conditions, and overall confidence.”

In a speech on Tuesday, he pointed out that the inflation outlook faces risks that are “not only high but also asymmetric, closely linked to geopolitical developments.”