The sharp rise in energy prices in the second quarter of this year has inevitably revived comparisons with the 2021-22 energy shock.
While the ECB notes that the nature of the shock this time around is different to the one back then, there is one particular detail in their latest economic bulletin which arguably stands out more. And that is changes in wholesale gas prices may now feed through into euro area consumer inflation more quickly than in the past.
According to its survey of national central banks, wholesale gas price changes are expected to show up in HICP gas inflation within one to three months across more than half of the euro area. Back in 2022, considerably more of that pass-through could take well over a year.
But why does this matter exactly?
It matters because the ECB is now already dealing with an awkward inflation backdrop.
The central bank has had to adjust its policy position earlier this month by raising key interest rates by 25 bps as the Middle East conflict and energy shock pushed up its inflation outlook. Policymakers have also warned that they are watching not just the initial energy shock, but its indirect and second-round effects.
Now, I wouldn’t read the ECB’s latest research as automatically pointing to much higher inflation and in turn another rate hike. ECB president Lagarde has already pushed back against the idea that interest rates simply move in lockstep with energy prices.
However, what the bulletin might be telling us is that the window in which policymakers have to determine whether a gas-price spike is temporary might be shorter than anticipated.
That makes the next few euro area inflation releases particularly important. Markets should be watching whether higher energy costs remain isolated in headline inflation or start bleeding more visibly into services, goods prices, and inflation expectations.
And eventually, wage growth numbers will also come into focus even more. If firms face higher energy bills while labour costs remain elevated, the ECB will be much more sensitive to evidence that businesses are passing those costs on.
For the rates market, the equation hasn’t really changed. Higher gas prices on its own are only the first part of the story. The bigger question remains whether the shock starts changing the trajectory of underlying inflation.
But with this latest information, perhaps the timing of deciphering the full equation has changed a little bit. It is no longer a case of maybe needing to wait for a year, it could be in the next few months.
So if that happens sooner than later, markets may also have to reprice the ECB outlook much quicker than before.
This article was written by Justin Low at investinglive.com.