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Ukraine war pushes eurozone's inflation to a record 7.5%

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By Jorge Liboreiro
Inflation in the eurozone continues to hit new records amid the Ukraine war and a persistent power crunch.
Inflation in the eurozone continues to hit new records amid the Ukraine war and a persistent power crunch.   -   Copyright  Martin Ruetschi/AP2001

Russia's invasion of Ukraine has thrust the eurozone into a new economic reality where high inflation is no longer a temporary headache and seriously threatens to undo the gains of the post-pandemic recovery.

Inflation in March reached 7.5% on an annual basis, an all-time high for the eurozone.

The figure represents a stunning rise compared to one year ago when inflation was 1.3%, well below the 2% target of the European Central Bank.

The March data is the first reading from Eurostat that takes into account the consequences of the Ukraine war, which has now entered its second month with no resolution in sight.

Annual inflation – the rate at which prices for goods and services change over time – has been steadily rising since late summer, when a mismatch between supply and demand sent gas prices soaring.

The trend persisted throughout winter when low temperatures pushed electricity consumption and considerably worsened after President Vladimir Putin gave orders to invade Ukraine.

The conflict plunged the global economy, still reeling from the pandemic, into uncertainty and turmoil. A broad range of Western sanctions has upended trade with Russia, the EU's main energy provider.

The bloc gets over 40% of its gas from Moscow, mainly through pipelines. Even if gas has so far been exempted from sanctions, the war has intensified price volatility across the continent.

The Dutch Title Transfer Facility, Europe's leading benchmark, shows that prices remain stubbornly above the €100 megawatt-per-hour mark, compared to less than €20 in early 2021.

March's inflation reading reflects this new normal: the energy sector has had an impressive surge of 44.7% – driving the entire eurozone on an upward trajectory.

Food, alcohol and tobacco increased 5% compared to 1.1% a year ago due to seasonal factors and higher costs for transportation and fertilisers.

No member state has managed to escape high inflation, with some even registering double-digit figures: Lithuania (15.6%), Estonia (14.8%), the Netherlands (11.9%) and Latvia (11.2%).

The situation has become politically toxic for some governments, which are under enormous pressure to mitigate soaring bills. Spain and Portugal have successfully lobbied their peers to implement exceptional caps on electricity prices.

The worrisome numbers are set to pile further pressure on the European Central Bank, whose mandate is to maintain price stability.

The institution had for months insisted that high inflation was a temporary phenomenon resulting from the economic recovery and the generous fiscal stimuli injected by governments. But the war has thrown the analysis out of the window and turned high prices into a long-term challenge.

"Europe is entering a difficult phase. We will face, in the short term, higher inflation and slower growth. There is considerable uncertainty about how large these effects will be and how long they will last for," ECB President Christine Lagarde said earlier this week at an event in Cyprus.

"The longer the war lasts, the greater the costs are likely to be."

The ECB is expected to end its pandemic-era programme of quantitative easing in the summer and possibly approve a first hike of interest rates in the fourth quarter of this year.

Interest rates in the eurozone have been negative since 2014, a policy introduced by Lagarde's predecessor, Mario Draghi, as a response to sluggish inflation following the European debt crisis.

When inflation grows, interest rates are expected to follow suit. Those who lend money demand higher rates to ensure they don't lose value when borrowers pay them back in the future.

High inflation is not a problem exclusive to the eurozone. Other advanced economies have too been hit by the fallout from the war: the US registered 7.9% inflation in February, while the UK recorded a 6.2% rate. In Canada, inflation rose to 5.7% on yearly basis.