'Some inflation alarms are ringing again' for ECB interest rates
On Due Focus The Ecb’s Own Survey Monday Is Market For The Inflation The Next Big Expectations
Freezing winter weather seems a remote concern as continental Europe swelters, but traders and strategists got a reminder last week of the fragile energy security and bond-market risks.
The price of wholesale gas leapt almost 30% in one day after strike threats in Australia jolted investors.
ING, Rabobank, and Saxo Bank recommend positioning for a hawkish pivot from the European Central Bank as energy prices rise again, saying officials will look to stop long-term inflation expectations from drifting ever higher.
“Suddenly some inflation alarms are ringing again,” said Benjamin Schroeder, senior rates strategist at ING.
“Recent swings in the price for natural gas highlight the lingering risk of supply disruptions to the more benign inflation dynamics of late.”
The next big focus for the market is the ECB’s own inflation expectations survey due on Monday.
But energy prices are ailing a host of markets including the UK, which lacks natural gas storage. Britain issues new inflation data on Wednesday.
While Europe’s cold-weather supplies are plentiful, the continent is still paying four times more than the US and about double what it was before the pandemic.
As energy prices jumped, a market gauge of long-term inflation expectations tested the highest level since 2010 last week, which traders say will make it hard for the ECB to justify an end to its tightening cycle.
Mr Schroeder at ING cautioned that ECB hawkishness could escalate to contain the price-growth risks.
He warned against jumping into curve-steepening trades — bets that yields on longer-dated bonds will rise faster than shorter notes.
Markets should not underestimate the central bank’s “resolve and persistence”, he said.
Europe’s reliance on liquefied natural gas imports was turbocharged by Russia’s invasion of Ukraine.
Weaning itself off Russian energy supplies fed the bout of inflation that started last year and risks fanning future price pressure as the region remains highly vulnerable to any disruption to global energy markets.
Money-markets currently price a 40% chance of a quarter point hike from the ECB in September, with a further 66 basis points of cuts priced for next year.
Rabobank echoed the likelihood that the ECB will need to show “more determination” to deal with inflation given the risk of further upward energy shocks.
“Energy is a really important crux for the ECB,” said Lyn Graham-Taylor, a senior rates strategist at Rabobank.