Eurozone February CPI rose 1.9% year-on-year, exceeding expectations! Iranian risks push up oil and gas prices, market rate hike expectations rise.

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Eurozone inflation unexpectedly accelerated in February, with core price pressures spreading beyond expectations, while the sudden spike in energy prices triggered by the Middle East conflict is adding new uncertainty to the previously stable inflation path.

According to data released by Eurostat on Tuesday, Eurozone consumer prices in February rose 1.9% year-on-year, higher than January's 1.7% and analyst expectations (1.7%). Excluding food and energy, core inflation also rebounded more than expected to 2.4%, and service inflation climbed to 3.4%.

Meanwhile, military actions around Iran are roiling oil and gas markets and raising the risk of imported inflation. European natural gas prices have risen more than 70% since Friday's close, and the global benchmark Brent oil has climbed above $80 a barrel.

On the policy front, European Central Bank chief economist Philip Lane said in a Tuesday interview with the Financial Times that the central bank will "closely monitor developments." Interest rate hike bets in the derivatives market have increased; according to Bloomberg data, traders now price in about a 50% chance of a 25-basis-point ECB rate hike this year.

Inflation Data: Core and Services Components Strengthen Again

The rebound in February inflation exceeded market expectations. Rises in food and service prices offset the previous drag from low energy prices, lifting overall inflation from 1.7% to 1.9%.

The “domestic inflation” indicator, which is more closely watched by the ECB, also picked up. Core inflation rose from 2.2% to 2.4%, and service inflation rose to 3.4%, suggesting price pressures are not solely driven by energy.

The ECB will update its quarterly forecasts at its next meeting in less than three weeks. The central bank had projected Q1 inflation at 1.9% in December last year.

Energy Shock: Oil and Gas Increases May Quickly Feed Through to End-User Prices

The focus now is on how long the Iran-related conflict will affect energy supply and transport, and how quickly the rise in oil and gas prices will transmit to consumers.

Reuters points out that fuel retailers often pass cost increases on to drivers within days, so if the conflict continues to constrain production or transport, the price impact could be quite rapid.

Institutions have begun quantifying the potential impact. Reuters, citing JPMorgan, said a 10% rise in the Brent price denominated in euros would push up overall Eurozone inflation by about 0.11 percentage points within three months.

Based on last week's changes in energy prices, if prices stabilize at current levels, inflation may be lifted by about 0.2 percentage points.

Policy Implications: ECB Emphasizes "Watching for Persistence," Cautious About Second-Round Effects

ECB officials currently feel "comfortable" keeping borrowing costs at 2%, believing inflation will return to target and the economy will maintain moderate expansion. But Bloomberg notes that the Middle East conflict increases uncertainty.

Philip Lane mentioned in the Financial Times interview that the ECB previously considered a scenario in which war in the Middle East disrupts energy supply, potentially causing a "sharp spike in energy-driven inflation and an abrupt output drop."

In terms of policy reaction, Reuters quoted Societe Generale as saying that, since inflation is still expected to be below 2% in 2026–2027, there is no urgent need to adjust policy in the short term. Only if oil prices exhibit a "sustained and significantly greater" rise, with enduring second-round effects, would there be grounds for tightening.

Reuters also stressed that the ECB typically downplays temporary energy price volatility, and policy transmission lags limit its ability to suppress short-term price pressures.

Market Pricing: Rate Hike Bets Rise, German Short-Term Yields Climb

The energy price surge has led the rates market to reprice. According to Bloomberg data, traders now see a 50% chance the ECB will hike rates by 25 basis points this year.

This shift in expectations has intensified short-term government bond sell-off. The yield on the two-year German government bond, which is sensitive to rate expectations, has risen by 0.2 percentage points this week to 2.2%.

Going forward, the key variables that will determine the path of European inflation and interest rates are the duration of the conflict, whether oil and gas prices remain high, and whether more persistent second-round effects appear in services and wages.

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