The energy crisis continues to worsen, driving up inflation expectations and prompting political reaction. Oil prices continued their surge above USD84 pr barrel, sa gas shortages continued to spill over into oil markets. While, natural gas prices in Europe fell back slightly from last week’s peak, they remain four times higher than pre-crisis levels. Although the spike in energy prices has yet to feed broader inflation, inflation markets continue to price in higher inflation in the euro area in 5-10 year’s time to its highest levels since 2014. To mitigate the increasing costs to the consumers and companies, the European Commission this week presented a toolbox of relief measures to be applied in member countries, including emergency income support to households, state aid for companies and targeted tax reductions. These measures come on top of the already announced temporary VAT cuts in Spain and Italy, which together with Greece are also providing subsidies for fuel payments. In the US, headline inflation increased faster than expectations in September while core inflation (excluding energy and food) only showed modest increases.
The surge in inflation expectations has also prompted expectations of earlier tightening of global monetary policy. In the US, financial markets are now a 50% chance of an interest rate hike by the Federal Reserve in July next year, while it has almost fully priced in a rate hike by September. We partly agree with this view as we changed our Fed call this week to assume two rate hikes in second half of 2022 (September and December), see Fed Research – Powell likely to remain chair and hike twice next year, 14 October. This week, Fed minutes from the September meeting showed that there is broad consensus in the policy committee to start the tapering in November or December. The surge in inflation expectations have also prompted market expectations of a rate hike by the ECB, where 10bp is priced for January 2023, which we think is far too premature, see discussion in Reading the Markets EUR: Markets are out of sync with ECB guidance, 14 October.
Meanwhile, the global economy is showing signs of abating momentum. This week the ZEW survey for Germany was another print confirming slowing economic activity and outlook in Germany. While the expectations component were still holding up at 22.3 (from 26.5 in Sep), it is nevertheless declining. Not surprisingly the current situation component also declined, but the magnitude of that decline was bigger than expected pointing to headwinds for the German economy in the near future. Despite the higher energy prices and weakening economic momentum global risk sentiment held up relatively well.
Next week, focus turns to Preliminary October PMIs for the UK, the US, Japan and the euro area. In the euro area, focus will be on whether supply constraints and mounting energy crisis are affecting companies’ order books and cost situation. We will also get the details from the September HICP release on Wednesday, giving more clues what drove the surge in core inflation to 1.9%. It is also worth keeping an eye on consumer confidence on Thursday for any signs that rising energy prices are denting consumers’ willingness to spend in Q4. In the US, it is the last week where the Fed members can guide markets ahead of November meeting before the blackout period kicks in on Saturday 23 October In the UK, the CPI inflation for September on Wednesday will attract attention given Bank of England hawkishness.
