Euro area inflation increased to 2.5% in March, with the rise attributed to higher energy prices linked to the Iran War. Core inflation eased to 2.3%.
Commerzbank linked the March data to the European Central Bank (ECB) scenario based on energy prices recorded on 11 March. The ECB also published two other scenarios that assumed higher energy prices.
Inflation Scenario Implications
The March reading aligns most closely with the mild scenario, which projects inflation moving only slightly above 3% in the second quarter. Based on this, the article says multiple ECB rate rises are less likely.
It states that core inflation may rise later in the year due to lagged effects from higher energy and fertiliser costs, even if hostilities end within two months and oil prices fall. It adds that the effect could be seen by the fourth quarter at the latest, countering slower labour-cost growth.
The article expects the ECB to raise key rates once in April or to signal a rise in June. It notes that April inflation data will be released on 30 April, the day of the next ECB Governing Council meeting.
The March inflation print shows a clear split that traders must watch. Euro area headline inflation hit 2.5%, almost identical to the 2.4% figure from March 2024, but this time it is driven solely by the energy shock from the Iran War. The crucial detail is that core inflation, which excludes energy and food, has actually cooled to 2.3%, suggesting underlying price pressures are not yet broad-based.
Trading Setup Into The ECB
This situation creates a mismatch between market expectations and central bank reality. We see markets pricing in over 60 basis points of ECB rate hikes by the end of the third quarter, anticipating a strong reaction to the headline number. However, with core inflation falling, the ECB is more likely to follow its mildest scenario, pointing to just one more hike at most in the coming months.
Traders should consider positioning for an ECB that is less hawkish than the market currently implies. This could involve using interest rate swaps to receive the floating rate and pay a fixed rate, betting that the path of short-term rates will be lower than priced in. Options strategies that profit from a cap on rate hikes, such as buying calls on Euro-Bund futures, could also be effective.
We remember the aggressive hiking cycle of 2022-2023, which is likely fueling the market’s current hawkish stance. But the context then was broad-based inflation, whereas now the price pressure is narrow and driven by an external supply shock. This difference is key and supports the view that the ECB will be hesitant to tighten financial conditions too aggressively and risk harming the economy.
The main window for this trade is in the weeks leading up to the ECB’s April 30th meeting. Implied volatility will be high due to geopolitical uncertainty, so traders should be mindful of the cost of options. The key will be to watch energy prices and any statements from ECB officials that hint towards looking through this energy-driven inflation spike.
