ECB: Modest Rise In EUR 5y5y Inflation Swaps On Middle East Tensions

Today’s spike higher in brent crude and natural gas futures has had a modest impact on long-term EUR inflation swaps. The 5y5y swap is up 2bps to 2.0950%, with the bulk of the upside move concentrated in shorter-dated swaps. That’s still contributed to a light hawkish move in ESTR forward rates though, with the 1y1y rate up 4bps to 1.75% on the session.

• For the Eurozone inflation outlook and therefore the ECB reaction function, the most important risk to monitor is whether the latest escalation of Middle East tensions impacts actual global oil/gas supply or disrupts key shipping routes in the region. It’s too early to make firm conclusions on that front right now.
• Energy price volatility can have a meaningful impact on the ECB’s headline inflation projections (most recently to the downside in the June forecast round), but the Governing Council is generally happy to look through such changes if they are short-term in nature.
• However, if increases in energy prices become more persistent and exhibit supply shock dynamics, the bar to a Governing Council response may be lower than in the previous decade (e.g. prior to Covid and the Russia-Ukraine invasion). ECB President Lagarde’s recent speech on the ECB’s ongoing strategy assessment discusses these trade-offs in more detail (see here).
• In its June macroeconomic projections (here), the ECB conducted its regular sensitivity analysis on the baseline projections to changes in energy price assumptions. The conclusion was that “alternative paths for oil and gas commodity prices suggest risks for inflation are overall tilted to the upside”.  These upside risks were mostly related to gas prices, with the oil market risks more balanced.