Natural Gas, Not Oil, Is Key Inflation Concern in Europe

Soaring energy prices have rekindled inflation fears in Europe since the Iran war disrupted oil and gas flows, but policy makers and bond markets appear to be more concerned about the jump in natural gas prices rather than the increase in crude oil futures.

European benchmark natural gas prices have hit a five-month high in recent days, as Europe scrambles for LNG supply to fill gas storage sites ahead of the winter.

Since the Middle East crisis began, Europe has started losing the competition with Asia for spot LNG supply amid spiking prices in the absence of most Qatari LNG term volumes.

The Iran war and the intensified competition from Asia came just as Europe is trying to build in the spring and summer natural gas inventories for the next winter.

Current storage levels are about 63% full, data from Gas Infrastructure Europe shows. That’s the lowest level for this time of year in nearly two decades and well below the five-year average.

The spiking gas prices threaten to raise inflation further and prompt interest rate hikes beyond current expectations. In the European bond markets, yields on the key UK and German bonds have surged to multi-decade highs amid fears of stubborn inflation due to the spike in natural gas prices.

“Natural gas prices have taken over as the key driver of yields,” Jamie Searle, European rates strategist at Citigroup, told Bloomberg.

According to Emma Moriarty, portfolio manager at CG Asset Management, “The natural gas price is more relevant to the UK and Europe and never really recovered in any of the ceasefires and continues to leg higher.”

Meanwhile, higher energy prices boosted inflation in both the UK and the Eurozone, with the July prices accelerating from the previous month and jumping from a year earlier.

The European Central Bank (ECB), which in June raised key interest rates for the euro area for the first time since 2023, is overwhelmingly expected to announce another hike in September, but stop the rate increases there.

By Charles Kennedy for Oilprice.com

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