Eurozone inflation rose more than expected in September and is likely to rise further in the coming months, due to high energy costs, keeping pressure on the European Central Bank to raise interest rates further.
Inflation in the 21 countries that use the euro rose to 3.8% in September, from 3.2% a month earlier, beating expectations of 3.6% in a Reuters poll. The rise was driven mainly by fuel and natural gas prices and, to a lesser extent, food costs.
Meanwhile, core inflation, a closely watched indicator that excludes volatile food and energy prices and signals underlying inflation trends, rose to 2.5% from 2.4%, due to rising services prices, data from Eurostat, the European Union's statistics agency, showed on Friday.
The figures are likely to send mixed signals for the ECB.
The increase in headline inflation further above the 2% target is concerning and will strengthen demands for further interest rate increases, following two interventions made during the summer.
Will the ECB maintain its "cautious" response to monetary policy?
However, the limited increase in core inflation indicates that high energy costs have not yet triggered what are known as second-round effects, which could trigger an inflationary spiral that is difficult to curb.
This would suggest that the ECB may stick to its “cautious” monetary policy response, a loosely defined concept that markets interpret as interest rate increases spread over time, perhaps in line with the release of quarterly economic forecasts.
In fact, investors are expecting up to three more hikes in the ECB’s deposit rate, which is currently 2.5%, over the next year. However, the likelihood of a hike this month is considered almost negligible and the upcoming hike was not fully priced into market prices until January.
However, these expectations change rapidly, and even policymakers themselves admit that their predictions are highly uncertain.
The members most inclined towards tighter monetary policy argue that energy costs have been too high for too long and, therefore, it is inevitable that they will start to cause second-round effects. According to them, the recent increase in natural gas prices will be transmitted more quickly than in the past to core inflation, raising the costs of everything from electricity and heating to business expenses.
Others, however, argue that the labor market is relatively weak, so workers are unlikely to demand large wage increases. Also, the recent sharp rise in long-term borrowing costs is expected to curb price growth.
In the end, the decisive factor for the next decision on interest rates may be more financial stability than inflation itself.
Borrowing costs have risen sharply, largely as U.S. bond yields surged to 24-year highs, weighing on all borrowers. But investors are also demanding a higher premium to hold riskier assets, while the spread between French debt yields and comparable German bonds has widened to the highest levels in decades, raising questions about debt sustainability.
Economists say the ECB may prefer to remain on the sidelines for now and not add to the turmoil in markets, especially since inflation trends do not require urgent or strong intervention./ Reuters
