Euro-Area Core Inflation Hits Record, Backing Case for ECB Hikes

(Bloomberg) — Underlying inflation in the euro area hit a record in March, handing ammunition to European Central Bank officials who say interest-rate increases aren’t over yet.

Most Read from Bloomberg

The rise to 5.7% in the core price reading, which strips out volatile items like fuel and food costs, came alongside a record plunge in headline inflation to 6.9% from 8.5% in February.

As the energy spike that followed Russia’s attack on Ukraine drops out of inflation readings, ECB officials are increasingly focused on the underlying measure — reflecting concern over firms hiking prices and workers demanding higher salaries to make up for lost purchasing power.

Divergence in the two price gauges can be seen in the region’s biggest economies, with underlying price growth barely budging in Spain even as the headline measure almost halved to just 3.1%.

Money markets appeared to focus on the decline in headline inflation, paring rate-hike wagers. Investors are pricing a 3.61% peak by October compared with as high as 3.71% before Friday’s data. Germany’s two-year yield was 2 basis point higher at 2.73%, having earlier risen to 2.83%.

The ECB last month raised its main rate to 3% but offered no guidance on what happens next, citing the financial turmoil. Since then however, several policy makers have insisted more tightening will be necessary.

What Bloomberg Economics Says….

“The March inflation reading adds to the case for additional tightening from the ECB. That follows comments from even dovish policymakers about the need for further hikes, now that stress in the banking sector has receded.”

—Maeva Cousin, senior economist. Click here for full REACT

After 3.5 percentage points of rate increase since last July, ECB President Christine Lagarde said this month that officials “will be looking to see a sustained downward turn in underlying inflation measures to be confident that the inflation path will converge to our target in the medium term.”

Returning to that 2% goal has become more complicated in recent weeks due to turbulence in the financial sector that culminated in UBS Group AG’s takeover of Credit Suisse Group AG.

While the upheaval may lead to more restrictive lending — a disinflationary force — “it’s completely open for now how big that effect” will be, ECB Executive Board member Isabel Schnabel said this week.

For now, the banking stress is easing — prompting more hawkish ECB policymakers to urge further rises in borrowing costs.

Such calls are backed by an economy that’s proved surprisingly resilient in the face of the energy crisis. Surveys by S&P Global pointed to firmer business activity in March, albeit driven exclusively by the services sector.

The labor market has also remained robust throughout the war in Ukraine, with separate data Friday showing unemployment stable at 6.6% in February.

There may be a downside to such developments, however. ECB economists warned Thursday in a blog post that a feedback loop involving higher wages, widening corporate profit margins and rising prices “risks strong second-round effects.”

–With assistance from Joel Rinneby, Alessandra Migliaccio, Barbara Sladkowska and James Hirai.