Eurozone Inflation Hit Record High in March as War Put a Chill on Business By

© Reuters.

By Geoffrey Smith 

-- Inflation in the euro zone hit its highest level since the creation of the single currency in March, as a combination of loose fiscal and monetary policy, supply chain constraints and surging energy prices mixed a toxic cocktail for the economy.

The consumer price index rose 7.5% on the year, from 5.9%, after leaping 2.5% in the month of March alone. The rise in core prices, which exclude more volatile elements such as fuel and energy, was even more severe at 3.0%. 

Economists had expected the headline annual rate to rise only to 6.6%. 

The numbers were released only a couple of hourse after a raft of closely-watched business surveys showed business activity slowing sharply in March, although they still continued to signal economic expansion. IHS Markit's purchasing managers index for Eurozone manufacturers fell to 56.5, its lowest level in over a year and also worse than consensus forecasts. The data are among the first to incorporate the timeframe since Russia invaded Ukraine in late February, sparking the worst armed conflict on the continent for 30 years.

The data will pile pressure on the European Central Bank to tighten monetary policy faster than it currently intends to do. The ECB's deposit rate is still stuck at -0.5%, and it doesn't plan to raise it until it has wound down its bond-buying program, which will happen no earlier than the summer under its current guidance. 

"There may be an acceleration in the pace of the QE program taper, but any ECB movement on rates seems unlikely until the end of Q3," said Mark Dowding, chief investment officer of BlueBay Asset Management, in a note to clients.

However, he suggested that year-on-year rates are unlikely to rise much further, due largely to base effects. By summer,, he noted "inflation is likely to be heading lower. Therefore, we may currently be witnessing a moment of peak pressure on central banks."

The euro was relatively little affected by the numbers, falling 0.1% to $1.1055, while the yield on the benchmark German 10-Year  government bond rose three basis points to 0.58%, having hit a four-year high of 0.72% earlier in the week in response to preliminary German data for the month, before falling sharply on Thursday.

Markets are currently betting that the ECB will succumb to the pressure and raise interest rates more quickly, following the example of a U.S. Federal Reserve which has drastically accelerated its timeframe for tightening monetary policy in recent months. Short-term interest rate futures suggest the ECB may raise its key deposit rate to 1.5% by the end of 2023. 

Earlier this week, ECB President Christine Lagarde stressed again that any rises in interest rates would be gradual. and that the spike in prices is still likely to be temporary, even though it will be higher and last longer than first expected. The ECB's staff forecasts - which will come under increasing scrutiny in the light of the current overshoot - still assume that core inflation will be below 2% in 2023 and 2024.

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