Euro zone inflation surges past ECB target on oil shock

FRANKFURT: Euro zone inflation soared past the European Central Bank's 2% target this month due to surging oil and gas prices, heightening a policy dilemma as expensive energy is a drag on growth but also risks generating a self-reinforcing inflation spiral.

Oil prices have nearly doubled as a result of the Iran war and the ECB is now debating ‌whether to raise ⁠interest rates ⁠to prevent this surge from becoming entrenched in the price of other goods and services. Overall inflation in the 21 countries sharing the euro currency jumped to 2.5% in March from 1.9% a month earlier below expectations for 2.6% in a Reuters poll of economists, as energy costs rose 4.9%.

A closely-watched figure on underlying inflation, which excludes volatile food and energy, meanwhile fell to 2.3% from 2.4%, data from Eurostat, the EU's statistics agency showed on Tuesday.


HIKE OR LOOK PAST?
Basic economic theory argues that central banks should look past one-off price shocks generated by ⁠supply disruptions, especially ‌because monetary policy works with long lags.

But a quick rise in energy inflation can easily broaden out if companies start building this into selling prices and workers begin demanding higher ⁠wages for the loss of disposable income. The public may also start doubting the ECB's resolve if it remains idle, firming the case for rate hikes even in the event of large but not so persistent inflation episodes, ECB President Christine Lagarde said last week.

Financial markets now see three interest rate hikes from the ECB this year, with the first in either April or June. While some policymakers, such as the influential Bundesbank head Joachim Nagel, said that a rate hike as soon as April was an option, others, including ECB board member Isabel Schnabel, have warned against hasty ‌action.

But policymakers agree that the ECB must act if energy starts generating second round price pressures, especially since domestic inflation had been above 2% for years.

Services inflation, the single largest item in the consumer price basket and ⁠the key gauge for domestic inflation fell to 3.2% in March from 3.4% a month earlier.

Part of the issue is that the ECB was late in recognising the inflation problem in 2021/22, arguing for months that the surge was transitory and would pass. It only raised rates when price growth hit 8%, forcing the central bank into its steepest tightening cycle in its history.

But the bloc is now in a very different position, so comparisons with 2022 are not entirely valid.

Rates are already higher, budget policy is tighter, the labour market has been weakening for months and there is no pent-up demand created by pandemic-era lockdowns.

The ECB will next meet on April 30.