Eurozone annual inflation quickens to 3.8% in September

• The preliminary eurozone consumer price index rose 3.8% year-on-year in September, exceeding the 3.6% consensus forecast.
• This follows a 3.2% increase in August.
• The core measure, excluding food and energy, climbed 2.5% on the year, matching expectations.
• The prior reading was 2.4%.

The latest data confirm that inflation is still accelerating in the eurozone as the third quarter concludes. Energy prices were the main driver, surging 18.8% in September after a 14.3% increase in August.

In addition, food and services prices also rose. The cost of food, alcohol and tobacco increased 1.4% annually, compared with 1.1% a month earlier. Services inflation accelerated to 3.2% in September from 3.0% in August. The services component is more significant for gauging underlying pressures, and contributed to a slight uptick in core inflation to 2.5%.

The European Central Bank now sees further reason not to consider inflation as fully tamed. It is grappling with both rising prices and tighter financial conditions, as bond yields have climbed markedly over recent weeks.

A headline rate approaching 4% offers little reassurance. The key issue going forward is whether the energy shock stays mostly confined or begins to seep more substantially into core and service prices.

The consumer price index tracks the cost of goods and services paid by households in the eurozone. The overall figure covers all items, while the core version excludes erratic food and energy components to provide a better view of persistent price trends.

Inflation is a critical factor for the ECB's interest-rate decisions at present. Since eurozone price growth already exceeds the central bank's 2% goal and energy costs are climbing rapidly, market participants are monitoring whether the shock is transmitting to services, wages and other core areas.

The September data arrive as energy-driven inflation intensifies across the currency bloc. Early national figures put HICP inflation at 3.3% in Germany, 3.4% in France, 4.1% in Italy and 5.0% in Spain, with core pressures still relatively moderate. Meanwhile, rising bond yields are tightening financial conditions, producing an awkward combination of higher inflation and increased downside risks to economic expansion.

A surprise above forecasts, especially in core inflation, may strengthen bets on additional ECB tightening. This would likely lift European bond yields and lend some strength to the euro, whereas higher rate expectations could pressure equities; the opposite outcome would have the reverse effects.

Market relevance is extremely high. Investors are already adjusting their ECB forecasts in light of the fresh inflation shock and a steep increase in eurozone yields. The main factor that could move markets is whether core inflation begins to accelerate, making it more difficult for the ECB to view the situation as mainly an energy-driven event.