Inflation in the Eurozone reached a three-year peak in September, driven primarily by rising fuel prices amid the ongoing conflict in the Middle East. Eurostat data released on Thursday showed the annual inflation rate climbed to 3.8 percent, up from 3.2 percent in August and exceeding economists' predictions of 3.6 percent.

The surge was notable across the bloc’s four largest economies, with Spain recording an inflation rate of 5 percent. Energy costs were the main contributor, with energy inflation rising to 18.8 percent from 14.3 percent the previous month. This spike marked the highest energy inflation since January 2023, during the energy price crisis triggered by Russia’s invasion of Ukraine.

Economists cautioned that further increases in oil prices could push headline inflation toward 4 percent in the coming months. Ulrike Kastens, an economist at asset manager DWS, noted that while headline inflation could rise, a comparable surge in core inflation—which excludes food and energy—was unlikely, citing subdued wage growth as a limiting factor.

Core inflation edged up to 2.5 percent in September from 2.4 percent in August. The services sector inflation, a key indicator of domestic price pressures, rose to 3.2 percent, continuing to exceed the European Central Bank’s (ECB) 2 percent target by a significant margin for over three years.

The persistent inflationary environment has heightened concerns about public debt sustainability in more heavily indebted Eurozone countries, such as France. These worries contributed to a rise in borrowing costs, with French 10-year government bond yields briefly touching 4.96 percent on Thursday—their highest level since 2002—before retreating slightly to 4.87 percent.

Since June, the ECB has responded to the energy-driven inflation shock by raising interest rates twice, both times by 25 basis points. Market expectations suggest there is about a 25 percent chance that the ECB will increase rates again at its upcoming meeting later this month, with a roughly 85 percent probability of a further hike by December. Current ECB borrowing costs would then reach 2.75 percent.

However, some analysts remain cautious about immediate additional tightening. Lee Hardman, senior currency analyst at MUFG, pointed to limited signs so far that higher energy prices have expanded into the broader economy, arguing that this, along with tighter financial conditions, may keep the ECB on hold until December. Francesco Pesole, FX strategist at ING, echoed this view, stating that despite headline inflation appearing high, core inflation data imply no clear evidence of so-called second-round effects taking hold.

September marked the seventh month in a row that inflation in the 21-country Eurozone remained above the ECB’s medium-term target, underscoring the ongoing challenge faced by policymakers as they balance inflation control with economic stability.