LONDON: Oil prices have re-established their role as the key driver of market-based inflation expectations in the euro zone, potentially bolstering a perception that the European Central Bank could start to wind down its bond-buying stimulus scheme.
Brent crude prices have risen about 12 percent in the past month to just over $50. Oil prices fell on Monday as Iraq said it wanted to be exempt from a deal among the Organization of the Petroleum Exporting Countries to cut production, though losses were capped by Iran saying it would encourage other members to join an output freeze.
Firmer oil prices have helped to push a closely-watched gauge of long-term inflation expectations in the euro zone, the five-year, five-year breakeven forward, close to 1.46 percent -- its highest since early June.
First, inflation expectations fell as investors downgraded their views on euro zone economic growth and inflation after the vote.
Second, a wave of safe-haven flows into top-rated euro zone government debt spilled over into broader fixed income markets, pushing rates on derivatives such as five-year, five-year breakevens lower as well.
"We're returning to a more normal environment post-Brexit where we see a higher, positive correlation between oil prices and inflation expectations," said DZ Bank strategist Christian Lenk.
Euro zone inflation is just 0.4 percent and expected to rise above 1 percent in the months ahead on the back of higher oil.
The further expectations pick up, the more confident the ECB is likely to feel about slowly unwinding monetary stimulus - a prospect that has unnerved markets lately.
US consumer prices recorded their biggest gain in five months last month, while British inflation recorded its biggest jump in two years.
In Britain, a fall of almost a fifth in sterling against the dollar since the June 23 vote has driven market gauges of future price rises to their highest since at least late 2013.
Comments by heads of major central banks such as Janet Yellen and Mark Carney suggesting a tolerance for higher inflation could encourage investors to price in a higher-than-anticipated trajectory for inflation, analysts say. While five-year, five-year forwards in the euro bloc -- which shows where markets see 2026 inflation forecasts in 2021 -- remain below the ECB's near 2-percent target, they are up 20 basis points from July's record lows around 1.25 percent.
"Central banks think they can have a stable process of inflation expectations returning to target but that could be wishful thinking," said Nordea chief strategist Jan von Gerich. "It's more likely we get an overshoot of inflation expectations than a gradual normalisation."
Comments
Comments are closed for this article.