Eurozone inflation jumps to three-year high of 3.8% as energy costs surge

Annual inflation in the eurozone has surged to 3.8% in September, hitting its highest level in three years and throwing a curveball at policymakers who hoped price pressures were beginning to ease.

The jump, up from 3.2% in August, comfortably cleared the 3.6% that economists had predicted. It also pushes the inflation rate much further away from the European Central Bank’s official 2% target, complicating the outlook for interest rates as winter approaches.

While the rise was expected to some degree, the sheer pace of the acceleration has caught markets off guard. Core inflation—which strips out volatile energy, food, alcohol, and tobacco prices to give a clearer view of underlying trends—offered some relief by landing at 2.5%, exactly in line with market forecasts.

Why are prices rising so quickly?

The primary engine behind the sudden jump is energy. Energy inflation shot up to 18.8% in September, its highest rate since January 2023.

The immediate cause is the ongoing conflict in the Middle East, which has rattled global energy markets and kept oil and gas prices high. Because energy costs feed into almost every sector of the European economy, from manufacturing to transport, a sustained period of high fuel prices threatens to derail the ECB's efforts to bring overall inflation back down to earth.

But some analysts warn that the problem is already expanding beyond raw fuel costs. Harry Woolman, global capital markets analyst at Validus Risk Management, said that while energy is still the main force, the September numbers indicate this is now becoming "more than an energy story".

The worry is that prolonged high energy bills will eventually force businesses to raise prices across the board, starting a second wave of inflation that is much harder to tame.

What will the ECB do next?

The sudden acceleration makes the ECB’s next governing council meeting on 29 October a critical moment for European monetary policy.

Before these figures were released, investors had begun to scale back their bets on further consecutive interest rate hikes. That shift in market expectations was partly prompted by comments from ECB President Christine Lagarde, who recently suggested that rising bond yields were effectively doing some of the central bank's tightening work for it by raising borrowing costs anyway.

The September inflation print makes that argument much harder to sustain. The central bank is acutely aware of its missteps in 2022, when it was slow to react to skyrocketing prices. Analysts believe policymakers will want to avoid a repeat of that scenario at all costs.

"A central bank mindful of the experience of 2022 will not want to wait for second-round effects to become entrenched before acting," Woolman said.

As a result, the pressure is back on the ECB to consider another interest rate increase when its governing council meets later this month, even as higher borrowing costs threaten to drag on the eurozone's economic growth.