Euro area inflation rises on energy shock, core trends stay limited

• Euro area inflation increased mainly due to energy prices linked to geopolitical tensions around Iran, while core inflation remained stable or slightly declined.
• Price pressures have not broadly spread across the economy: food, industrial goods, and services show weaker dynamics, limiting overall inflationary pressure.
• There is a risk of second-round effects: higher energy costs may gradually feed into other sectors, especially food and services, pushing core inflation higher over time.
• The European Central Bank is likely to remain cautious, with the baseline scenario pointing to at most one rate hike or simply signaling such a move.

On Tuesday, inflation data for the euro area was released. Inflation in the euro area accelerated noticeably in March, rising from 1.9% to 2.5% year-on-year. The main driver of this increase was energy prices, particularly fuels and heating oil, which reacted strongly to geopolitical tensions related to the conflict in Iran. At the same time, core inflation, which excludes energy and food, not only failed to rise but actually edged down slightly to 2.3%. The readings came in slightly below market expectations.

The data indicate that the increase in inflation is almost entirely due to rising energy prices. Energy price dynamics shifted from negative territory to clearly positive, directly lifting the headline inflation rate. Meanwhile, other components such as food, industrial goods, and services recorded a slowdown in price growth. This suggests that, for now, the conflict has not broadly spread across the economy. Additionally, government measures, such as tax cuts in Spain and Italy, have partially mitigated the impact of rising energy prices.

In the coming months, however, higher energy prices are expected to gradually feed through into other sectors of the economy. Rising production costs and fertilizer prices may translate into higher food and service prices, which could, with a lag, lift core inflation. Even if the conflict subsides in the near term, cost effects may persist through the end of the year, potentially leading to a renewed increase in core inflation in the fourth quarter.

Despite the rise in headline inflation, the current data remain consistent with the most dovish scenario of the European Central Bank. This means that pressure for aggressive interest rate hikes is limited. Under current conditions, the most likely scenario assumes either a single rate hike or merely a signal of such a move in the coming months.

The current situation shows that inflation in the euro area remains highly dependent on external factors, primarily the energy market and geopolitical developments. As long as inflationary pressure does not spread more broadly across the economy, the monetary policy response is likely to remain moderate. However, in the medium term, the risk of second-round inflation effects remains significant.