Key facts
- Spain's harmonized inflation rate increased to 5.0% in September, driven by rising fuel prices.
- Italy's headline inflation accelerated to 4.2% in September, with regulated energy prices up 25.9% and non-regulated up 22.2%.
- Europe's inflation problem is largely attributed to energy costs, particularly diesel, due to dependence on imports.
- The European Central Bank raised its deposit facility rate to 2.50% on September 10.
- ECB staff project headline inflation to average 3.0% in 2026, 2.5% in 2027, and 2.1% in 2028.
Europe is grappling with a renewed energy shock that is rapidly translating into higher consumer prices across several key economies, posing a significant challenge for the European Central Bank (ECB).
In September, Spain's harmonized inflation rate climbed to 5.0%, its highest in years, primarily driven by increased prices for fuels and lubricants, according to the national statistics agency INE. Spain's domestic Consumer Price Index (CPI) rose 4.9%, with core inflation at a more modest 3.1%.
Italy is also experiencing a similar energy-driven inflation surge. Preliminary data from Istat show headline inflation accelerating from 3.3% in August to 4.2% in September. Regulated energy prices saw a substantial year-on-year increase of 25.9%, while non-regulated energy prices jumped 22.2%. In contrast, Italy's core inflation remained significantly lower at 1.7%.
The divergence between headline and underlying inflation underscores that the current inflation problem in Europe is predominantly linked to energy costs. The region's reliance on imported oil and natural gas makes it particularly vulnerable to global energy price fluctuations. The recent rise in crude and fuel prices, exacerbated by the conflict in the Middle East, is quickly impacting transportation, manufacturing, and household energy expenses. Diesel prices have become a particular concern, as Europe depends on imported middle distillates, leading to higher crack spreads and freight costs.
While this situation echoes the energy crisis following Russia's invasion of Ukraine, a key difference so far is the limited second-round inflationary effects on the broader economy, as evidenced by Italy's low core inflation.
This distinction is crucial for the ECB's next policy moves. The central bank already increased its three key interest rates by 25 basis points on September 10, citing inflationary pressures from the Middle East conflict and warning that inflation would likely stay above target for an extended period. ECB staff forecast headline inflation to average 3.0% in 2026, 2.5% in 2027, and 2.1% in 2028, compared to the 2% medium-term target. However, policymakers are mindful of the uncertainty surrounding the duration of the energy shock and its potential to spread into underlying inflation.
Europe faces a difficult trade-off: aggressive rate hikes could further weaken an economy already strained by high energy costs, while a slow response risks embedding the oil shock into wages and inflation expectations. For now, the inflation problem remains centered on energy, with the critical question being whether this situation persists.