Eurozone inflation set to stay elevated through 2027

The Eurozone has so far avoided major inflation issues despite ongoing energy supply shocks. While market break-evens suggest contained inflation expectations, the situation is growing more complex. Higher energy prices, reduced fiscal support, rising food costs, and resilient economic activity all point to inflation staying above the European Central Bank’s (ECB) 2% target longer than anticipated.

Energy prices have surged due to the closure of the Strait of Hormuz following the Iran conflict. Brent crude now trades around $105 per barrel, with oil and natural gas prices expected to remain elevated. The full inflationary impact of these energy shocks is likely still ahead, as wholesale prices gradually affect utility bills.

Unlike the 2022-23 energy crisis, the current fiscal response is much more limited. EU energy subsidies peaked at €457 billion during the 2022 crisis, but today’s measures amount to just €14.5 billion, rising to €38.6 billion if extended through 2026. Europe must also replenish energy inventories, with gas storage facilities at only 71% capacity, historically low levels, raising concerns about winter energy costs.

Beyond energy, food prices are rising due to higher fertiliser costs and adverse weather linked to El Niño. While wage growth remains modest, there is a risk of broader inflation pressures if energy costs continue to climb. Recent economic data, including a strong composite PMI, indicate resilient activity, reducing the likelihood of natural demand-driven inflation relief.

Financial markets are already pricing in almost four additional ECB rate hikes over the next year, on top of the two already delivered. The ECB is expected to raise the deposit rate to 2.75% in December, maintaining a restrictive policy stance. Overall, inflation risks in the Eurozone remain skewed to the upside, with energy prices, constrained fiscal support, and resilient economic activity all contributing to prolonged inflationary pressures.