Flames from a gas burner on a stove are shown at a private home in this illustrative image taken on June 27, 2022. REUTERS/Stephane Mahe/Illustration/File Photo
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- Inflation and interest rate expectations in the eurozone and the UK are rising
- Sudden gloom contrasts with earlier hopes for climax
- Investors say divergence is growing with the US
LONDON, August 24 (Reuters) – Another dramatic rise in natural gas prices appears to have dashed any hopes of an easing of Europe’s inflation struggle as financial markets now brace themselves for higher prices, faster rate hikes and a deeper economic downturn.
Just a few weeks ago, signs that inflation in the United States – which tends to trigger global economic changes – might be peaking drove stocks higher and lowered government borrowing costs. Investors were betting that central banks would now pay more attention to the weakening of economies as a peak in the rate hike cycle nears.
Instead, this week began with a forecast from US bank Citi that UK inflation would soar to a near-half-century high of 18.6% by January, a forecast that dominated the front pages of UK newspapers on Tuesday.
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This comes as another explosion in natural gas prices showed little sign of slowing down, with Russia signaling further tight exports and European buyers scrambling for supplies ahead of the winter.
Gas prices are up nearly 40% in August and nearly 300% this year.
“The key is energy, energy, energy. There is an energy crisis, let’s face it, electricity prices are 10 times what they were before COVID, it’s a shock to the system,” said Thomas Costerg, senior economist at Pictet Wealth Management.
“The US and Europe are on different paths. We all knew that Europe’s Achilles heel is foreign energy and now they are paying the price for it,” he said, citing Europe’s dependence on Russian gas.
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‘FULLY REVERSED’
No wonder, then, that the mood quickly deteriorated. World stocks (.MIWD00000PUS) are down 4.3% last Tuesday from a 3-1/2 month high, the euro has slipped back below $1 and US 10-year Treasury yields are back at 3%.
Monica Defend, head of the Amundi Institute, predicts the euro will fall to $0.96 by December due to the weak European economy.
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There are growing concerns that central bankers gathering at this week’s Jackson Hole symposium are setting the stage for more aggressive rate hikes than previously expected. With no certainty about when the hike will end, investors are nervous.
“The market became increasingly confident that the recession would be the dominant theme, that central banks would be more dovish or dovish in their tightening of monetary policy,” said Richard McGuire, head of rates strategy at Rabobank. “Since the beginning of last week it has completely reversed itself.”
HIGHER INFLATION
Just take a look at market-based measures of inflation expectations. Short-term indicators in the Eurozone and UK jumped to record highs this week. ,
A long-term euro-zone headline watched by the European Central Bank (ECB) rose to 2.24% on Tuesday after falling below the ECB’s 2% target in July. .
ECB policymaker Isabel Schnabel warned last week that inflation expectations could be “unanchored” as the central bank speaks of a loss of confidence in the bank’s willingness to fulfill its mandate. Continue reading
Kenneth Broux, strategist at Societe Generale, called Schnabel’s comments a “pioneering moment” as central bankers fear inflation will not ease off fast enough.
In the UK, a similar inflation indicator rose to 3.82% this week from 3.4% at the end of July.
Two-year UK government bond yields, which traded at their highest levels since 2008, experienced their biggest weekly jump since 2010 after last week’s data showed inflation hit 10.1% in July. Investors on Tuesday bet the Bank of England wouldn’t stop rising until June 2023, and rates are around 4.2%. Before measuring inflation, they were expecting a peak of 3.25% in March.
Euro-zone markets have also raised where they believe ECB interest rates will peak next year, by about 50 basis points to about 2%, data from Refinitiv shows.
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Craig Inches, Head of Rates and Cash at Royal London Asset Management, said the rise in market-based indicators of inflation showed markets were now focused on “the next round of inflationary effects”. The causes range from a European drought and the gas crisis to pandemic-related delivery bottlenecks in China.
“There seem to be numerous stories that can point to more entrenched, embedded inflation,” he said, adding that markets are now asking “how much do interest rates need to go”?
Inflation expectations are also rising in the US, but the outlook for Europe looks much bleaker.
“Inflation in Europe should increase in the fourth quarter, but the magnitude of the increase we are now facing is a new event due to renewed increases in gas prices,” said Holger Schmieding, chief economist at Berenberg.
“It’s a new shock that wasn’t foreseeable a few weeks ago.”
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Additional reporting by Huw Jones and Marc Jones Editing by Mark Potter
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