Europe Gets Hit by Another Energy-Driven Inflation Shock

Europe’s latest energy shock is rapidly feeding into consumer prices, with inflation accelerating across some of the euro area’s largest economies and leaving the European Central Bank facing an increasingly uncomfortable policy dilemma.September data show particularly strong increases in southern Europe. Spain’s harmonized inflation rate jumped to 5.0%, up from 4.6% in August and its highest reading in several years. Spain’s statistics agency INE said rising prices for fuels and lubricants were among the main drivers. Spain’s domestic CPI rose 4.9%, while core inflation increased more modestly to 3.1%.Italy is experiencing a similar energy shock. Headline inflation accelerated from 3.3% in August to 4.2% in September, according to preliminary data from Istat. Regulated energy prices surged 25.9% year-on-year, while non-regulated energy prices jumped 22.2%. By comparison, Italian core inflation remained much lower at just 1.7%.The divergence between headline and underlying inflation highlights the extent to which Europe’s latest inflation problem remains an energy story.Europe is particularly exposed to global energy shocks because of its dependence on imported oil and natural gas. The latest surge in crude and fuel prices resulting from the Middle East conflict therefore works its way relatively quickly through transportation, manufacturing and household energy costs.Diesel has become an especially painful part of Europe’s latest energy shock. The region remains structurally dependent on imported middle distillates, leaving it exposed when global supplies tighten. Disruptions to Middle Eastern and Russian refining and trade flows have sent diesel crack spreads—the premium of diesel over crude—sharply higher, meaning European consumers are being hit by both elevated crude prices and unusually expensive refining margins. With replacement barrels increasingly competing for long-haul supply, higher freight costs are adding another layer to the price shock.The situation inevitably recalls the energy crisis that followed Russia’s invasion of Ukraine. There is, however, an important difference so far: the latest energy shock has not produced comparable second-round inflationary effects across the broader economy.Italy illustrates that divide particularly clearly. Energy prices rose 22.3% year-on-year in September, while core inflation was only 1.7%.That distinction could determine what the ECB does next.The central bank already raised its three key interest rates by 25 basis points on September 10, taking the deposit facility rate to 2.50%. The ECB explicitly cited inflationary pressure generated by the Middle East conflict and warned that inflation was likely to remain “well above target for an extended period.”ECB staff currently expect headline inflation to average 3.0% in 2026, 2.5% in 2027 and 2.1% in 2028, compared with the central bank’s 2% medium-term target. But policymakers have also emphasized the uncertainty surrounding the duration of the energy shock and the extent to which it eventually spreads into underlying inflation.That leaves Europe confronting an increasingly difficult trade-off.Raise rates too aggressively and the ECB risks weakening an economy already absorbing sharply higher energy costs. Move too slowly, and policymakers risk allowing the oil shock to become embedded in wages, services and inflation expectations.For now, Europe’s renewed inflation problem remains primarily an energy problem. The crucial question is whether it stays that way.By Charles Kennedy for Oilprice.comMore Top Reads From Oilprice.comLNG Canada to Double Export Capacity After Shell Approves Phase 2US Distillate Stocks Continue to Fall As Crude Inventories BuildIndia Looks to Boost Exploration as Hormuz Crisis Threatens Supply