After latest figures from the EU statistics office Eurostat show a rise in inflation in the eurozone in March, investment managers discuss the impact and the timing of a potential interest rate hike.

Eurozone inflation rose to 2.5 per cent in March from 1.9 per cent the previous month, marking its highest level in two years, according to flash estimates from the EU statistics office Eurostat.

Inflation had been expected to come in at 2.6 per cent, but the figures are still above the European Central Bank’s (ECB) 2 per cent target. The rise largely reflects a sharp increase in energy prices since the Middle East conflict began, which has caused oil prices to spike. Eurostat said that the energy component of the inflation data is expected to have risen to 4.9 per cent in March, compared with 3.1 per cent in February.

ECB President Christine Lagarde said last week that the central bank was watching regional data closely and would respond with interest rate hikes if necessary.

The central bank has also revised its growth and inflation forecasts for the medium term and expects economic growth of 0.9 per cent in 2026, with headline inflation averaging 2.6 per cent for the year.

Financial markets now see three interest-rate hikes from the ECB this year, with the first in either April or June.

“This is a sharp and uncomfortable departure from the benign price environment the European Central Bank had, until recently, been enjoying,” Katy Stoves, investment manager at UK wealth manager Mattioli Woods, said in a note.

“Although the number came in fractionally below initial forecasts, this is thin comfort given the pricing uncertainty created by the closure of the Strait of Hormuz. For much of the past year, eurozone inflation had been sitting tidily at or near the ECB's 2 per cent target; a hard-won achievement after the post-pandemic price surge and Russia/Ukraine war fallout. This latest print suggests that inflation fight is about to be anew.”

“Europe's dependence on gas, both for heating and industrial production, makes it particularly exposed to supply shocks of this nature, and it's likely, this month's CPI figure only captures the early stages of that disruption. If the conflict in the region persists, the inflationary impulse could intensify considerably over the coming months,” Stoves continued. “Against this backdrop, market participants are now increasingly pricing in a rate hike at the ECB's next monthly meeting.”

Meanwhile, Felix Schmidt, senior economist at Hamburg-headquartered private bank Berenberg, said that the longer the war drags on with higher inflationary pressures rising, the more likely it will be that the ECB will tighten monetary policy this year.

“Eurozone inflation is likely to peak above 3 per cent in the coming months. If the war continues to escalate, inflation could even rise briefly to well over 4 per cent,” Schmidt said. “However, the extent to which the energy crisis will impact inflation in the eurozone in the coming months also depends on the measures governments take. Reducing VAT on petrol or introducing price caps, both of which are currently under discussion in many member states, would curb the mechanical passthrough to inflation.”

“If the conflict in Iran has not subsided by the end of April, as we assume for our baseline forecast, and if the ECB feels the need to send a clear signal to the markets that, unlike in 2022, it will not react too late this time, the ECB may possibly increase its key interest rate at the end of April already,” he added.

The statement comes after central banks – the Bank of England (BoE), the European Central Bank, Bank of Japan and the US Federal Reserve – all kept interest rates unchanged last month, as expected, highlighting the severity of the Middle East conflict which has caused oil prices to surge.