EURi: Bull-flattening extends; Green inflation premia

Chart green up line 15 Jun 2022
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Euro inflation continued to bull-flatten with the front end and FRF leading the gains. BNPP looks at impact of net zero on inflation risk premia.

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  • Bull-flattening extends

  • Less carbon means more inflation risk: BNPP  

      

    Bull-flattening extends

    The euro inflation curve continued to bull-flatten today ahead of key US CPI data Wednesday. Still, the strength of the long end faltered after lunch with EUR 10y off the highs at 2.57% (+2.25bps) at the close even as EUR 1y advanced to 6.9075% (+7.5bps) after rising 8bps yesterday and 9bps on Friday. EUR 5y5y stalled at 2.075% (-0.75bps) as the curve flattened sharply and 10y10y came down to 2.33% (-1.75bps). French inflation and OATi outperformed by a couple of bps.

     

    Today's moves came against a backdrop of bear-steepening along the nominal curve. In the background Brent futures fell back under $96 late in the session, the Euro Stoxx lost 1.2% and 10y TIPS breakevens were unchanged while the 2y breakeven was up a bp.      

     

    Less carbon means more inflation risk: BNPP  

    BNP Paribas research this week features an interesting, longer-term look at the impact on inflation of the global move toward net zero. It concludes that policies to encourage the transition will tend to add to global inflationary pressures and upside risk:

     

    “The key stagflation risk we see is a delayed transition requiring steep rises in carbon prices. The large increase in global energy prices caused by the war in Ukraine is likely to accelerate the transition.”

     

    “Developed market central banks will ensure that a 1970s style outcome remains a worst-case scenario.”

     

    “In the transition, EU energy markets are likely to remain tight and prices volatile, with pressure to the upside.”

     

    “Inflationary pressures and price volatility arising from climate change and the necessary transition should see inflation risk premia rise and nominal rates curves remain at relatively flat levels.”

     

    “5y5y EUR and USD inflation swap rates have gone from trading at a premium of about 0.50–0.65% to their respective central bank targets (5y average), when realised inflation was broadly trading at target, to discounts of about −0.05% and −0.40%, respectively…We see scope for inflation risk premia to increase further, particularly in the US and EU, reflecting the potential for both more persistent inflationary pressures from the green transition and greater inflation volatility likely in response to the physical transition. Therefore, we think it would be reasonable to expect a return to the prior regime of about 0.5pp average risk premia to inflation targets.”

     

    “Central banks might face a challenge in mitigating the potential inflationary risks climate change and the green transition pose, for example if driven by supply-side pressures. With this in mind, markets might suspect central banks may be more tolerant of inflation overshoots (to perhaps avoid a recession), or even contemplate the idea of central banks raising their inflation targets.”