ECB rate hike looks nearly certain after inflation rises to three-year high

By Balazs Koranyi

FRANKFURT, Nov 4 (Reuters) - Euro zone inflation rose to a three-year high last month on surging food and energy costs and was set to rise further in the coming months, firming up the case for another European Central Bank rate hike in December.

Inflation in the 21 nations sharing the euro currency rose to 4.0% in October from 3.8% a month earlier, in line with expectations in a Reuters poll of economists, as energy inflation hit 20%, data from Eurostat, the EU's statistics agency, showed on Wednesday.

A more closely watched "core" figure, which strips out volatile food and energy prices, meanwhile held steady at 2.5%, in line with expectations, indicating that long-feared second-round effects have not yet materialised.

"Despite the lack of signs of second-round effects, today's inflation print adds to the already strong case for an ECB rate hike in December, as the central bank is concerned that the longer the energy shock goes on, the higher the risks of broader inflationary pressures becoming more entrenched," Nicola Nobile at Oxford Economics said.

Inflation has been climbing quickly above the ECB's 2% target this year as the US war with Iran has pushed energy costs higher, feeding through to retail prices for a bloc that imports the vast majority of its energy.

The ECB left rates unchanged last week but a long list of policymakers, including the influential heads of the German and Italian central banks, have already signalled that another move in December is now likely.

Financial markets are pricing between two and three rate hikes to the ECB's 2.5% deposit rate over the coming year, with expectations frequently shifting, in tandem with oil prices. 

Sweden's central bank, meanwhile, joined peers in tightening policy on Wednesday and signalled more hikes ahead over fears energy inflation could seep into the broader economy.

The Bank of England, meeting on Thursday, is expected to follow suit, lifting its own key rate to 4.00% as it also expects inflation to exceed 4% early next year.

FOOD PRICE CONCERN

In a potentially worrisome development for the ECB, food inflation continued to accelerate with non-processed food prices rising 4.6% compared to a year earlier.

This item makes up only a small part of the consumer price basket but contains some of the most frequently bought items by households. Rapid price changes could have an oversized impact on inflation expectations, economists say.

Services inflation, the single largest item in the consumer price basket, picked up to 3.3% from 3.2% while industrial goods prices rose 1.2% after 1.1% a month earlier.

While Wednesday's figures indicate energy inflation is still not generating second-round effects, expensive diesel and natural gas still risk seeping into the price of other goods and services, causing indirect effects that are bound to linger.

Low natural gas storage levels, meanwhile, create plenty of upside risk for heating costs, economists say.

This may not be so visible in data now but will likely show up in the coming months, especially in January, when some goods are traditionally repriced.

The ECB now expects inflation to hold above 4% for much of the first half of 2027 before falling quickly towards the "low twos", when high year-earlier figures get knocked from data.

(Reporting by Balazs Koranyi; Editing by Joe Bavier)