LONDON—The euro zone's inflation rate rose unexpectedly to its highest level for 29 months in March, official data showed Thursday, strengthening the case for the European Central Bank to raise interest rates for the first time in almost three years next week.
The annual inflation rate jumped to 2.6% from 2.4% in February, the highest level since October 2008 when the rate was 3.2%, the European Union's Eurostat agency said in a flash, or preliminary, estimate. economists had been expecting the inflation rate to dip to 2.3% in March.
The unexpected surge triggered a spike in the euro to $1.4233, although by late morning in London it had given away some of its gains to trade around $1.4212 compared with $1.4126 late Wednesday in New York.
"We were already in the camp that they [ECB] would hike interest rates in April. This reaffirms our conviction in that, and secondly...we think it actually is the first in a series of interest rate hikes," said Alan Clarke, an economist at BNP Paribas in London.
The ECB left its main interest rate at a record low of 1% at its last policy meeting on March 3, but ECB President Jean-Claude Trichet said risks to price stability were on the upside and a rate rise in April was possible, though not certain.
The ECB, which aims to keep inflation just below 2% over the medium term, last raised interest rates in July 2008. The central bank's main interest rate has been at a record low since May 2009.
In the last month Mr. Trichet and other ECB policymakers have stuck to or reiterated the language in the central bank's March 3 statement that "strong vigilance" was needed on inflation, seen by market participants as a hint that policy action is in the pipeline.
"The ECB has already signaled its intention to start the normalization of its interest-rates policy," Peter Vanden Houte, an economist at ING, said in a note. "In that regard we stick with our call for a 0.25 percentage-point rate hike in April, but based on today's figure at least one additional rate hike looks very likely this year."
The sharper than expected increase in consumer prices has put the ECB in a tough spot as it looks to tackle inflation while several countries in the currency area—such as Greece, Ireland, Portugal and Spain—continue to struggle with severe debt problems and high unemployment.
The governments of the countries at the heart of the euro zone's debt crisis are unlikely to be happy to see borrowing costs rise as they implement severe austerity measures to reduce their budget deficits.
Although economists expect the headline rate of inflation to rise further in coming months, core inflation—which excludes volatile items like energy, food, alcohol and tobacco—actually slowed to 1.0% on the year in February from 1.1% the previous month.
"The weakness of core price pressures and the ongoing problems in the peripheral economies suggest that a sustained monetary tightening is both unnecessary and potentially very damaging to the region," Jonathan Loynes, chief European economist at Capital Economics in London, said in a note.
Although no detailed breakdown is available with the March flash estimate, inflation has been driven higher in recent months by rising prices for energy, while higher costs for food, alcohol and tobacco have also played a part.
German inflation data released Tuesday gave a hint of what to expect.
Preliminary figures released by the country's Federal Statistics Office showed the annual inflation rate in Europe's biggest economy was stable at 2.1% in March, also the highest level since October 2008.
The statistics office said the inflation was fueled by large price increases for energy products. Economists said they expected German inflation to accelerate further, and some said higher energy prices could also feed into other areas such as transport and clothing.
Write to Nicholas Winning at nick.winning@dowjones.com
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