Distorted Gas Supply is European Economy’s Achilles’ Heel

Markets

It still are the same central banks, but with a different reaction function. A low inflation environment enabled them to conduct demand-stimulating policies from the great financial crisis up until the Covid-19 pandemic to counter any significant (potential) hit to growth. This weekend’s developments, but a decade ago, would have triggered the “transitory” energy-related inflation spike narrative with the focus directed on facilitating growth. Today’s different inflation context (>2%) and lessons learnt from the energy crisis some four years ago implies that central bankers will be vigilant to the inflation rather than the growth side of the story. Markets are clearly aware of that as seen in yesterday’s repositioning. When it comes to Europe, money markets again clearly err on the side of a rate hike as the next move. When it comes to the US (or the UK for that matter), they question the timing of the next rate cut (opting for delay) and the policy room left towards neutral. Daily changes on the US yield curve ranged between +6.8 bps (30-yr) and +10.9 bps (5-yr) with the 2-yr and 10-yr yield moving back above 3.4% and 4% respectively. Apart from the energy-narrative, US Treasuries lost additional ground after the release of the February manufacturing ISM. The ISM printed above the neutral 50-mark for a second consecutive month (52.4 from 52.6). The previous time that happened was in the fall of 2022. The index sported strong details with new order growth, a rising backlog, decent production volumes and slowed job shedding. Tariffs and metal prices (steel and aluminum) did propel the prices paid subindex to its highest level since June 2022 (70.5) and add to the Fed near term rate stability case. The German yield curve bear flattened with yields rising by 4.3 bps (30-yr) to 9 bps (2-yr). Distorted gas supply is the European economy’s Achilles’ heel after being cut off from Russian supplies. The largest LNG production site in Qatar was shut down yesterday following Iranian drone attack. They added to upward pressure on gas prices (Dutch TTF €44.5/Mwh from €32) coming from higher oil prices (Brent $80/b with Strait of Hormuz closed). The huge energy-dependence helps explaining underperformance of European assets in general. Main equity benchmarks lost up to 2.5% yesterday whereas the US managed to hold a status quo. EUR/USD lost first support at 1.1742 with the YtD low at 1.1573 being the next reference. Elsewhere, the Swiss National Bank had to officially step up verbal intervention threats after EUR/CHF was heading towards 0.90 for the first time ever (apart from 2015 volatility). Yesterday’s market dynamics remain in play today with US President Trump warning that “the big wave” is yet to come while continuous Iranian drone attacks spread chaos across the Middle East. Today’s eco calendar contains the February EMU CPI print. Our inhouse KBC Nowcast model points to 1.8% Y/Y inflation, suggesting upside risks to the 1.7% Y/Y consensus estimate. We expect energy prices to rise by 0.8% M/M to be down 2.5% Y/Y. The Iran conflict makes it likely that headline HICP will return to around 2% as early as March which might add to yesterday’s repositioning vibes when it comes to both the direction and (to a lesser extent) the timing of the ECB’s next move. A slightly stronger monthly impulse than in January should keep services inflation at 3.2 and core inflation at 2.2%.

News & Views

In a speech at a business meeting in Sydney, Governor Michell Bullock of the Reserve Bank of Australia (RBA) warned that the March 17 Policy meeting is a live meeting as the RBA board will “be actively looking whether or not it needs to move more quickly”. The comments come as monthly January inflation at 3.8% Y/Y surprised on the higher side of expectations and stays well above the 2-3% RBA target zone. At the same time, labour market data remained solid with the unemployment rate easing to 4.1%. Governor Bullock explicitly questioned the market assumption that the RBA will mostly likely wait for quarterly inflation data to adjust policy. The RBA last month raised its policy rate by 0.25% to 3.85% as inflation remains elevated, the labour market tight and as the economy meets capacity pressures. Tomorrow’s Q4 GDP figures (0.8% Q/Q expected) will give additional info. The 2-y Australian government bond yield jumps 14 bps to 4.3%. The market implied probability of a March rate hike rises from 15% to 30%. The Aussie dollar holds up well against a broadly strong dollar (AUD/USD 0.71).

February UK shop price inflation in February eased to 1.1% against a 1.5% rise in January. Even so, this increase is still in line with the 3-month moving average. Non-food prices fell 0.1% Y/Y, against growth of 0.3% in January. Food inflation increased 3.5%Y/Y in February, against growth of 3.9% in January. The British Retail Consortium comments that fierce competition between retailers is keeping price rises in check as do promotions. Falling global food costs also fed through, pushing food inflation down, with ambient food inflation dropping to its lowest level in four years. While promising, the BRC assess that prices are still rising and that many consumers remain under pressure. It also mentions the risk that government measures might “add further complexity if secondary legislation is implemented without an eye firmly on the potential consequences for the cost of doing business and hence the cost of living”.