EURi: EUR 1y back above 7% on energy, Germany

Gas tanker sunrise 11 Oct 2021
Euro inflation flattened again as the front end surged on the back of energy and uncertainty about Germany's plans to protect households.

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  • Still flattening on energy and Germany

  • Are real rates going high enough to get inflation down? DB  


    Still flattening on energy and Germany

    A combination of higher energy prices and uncertainty about the degree of pass-through into German inflation in coming months continued to lift the front end and bull-flatten the euro inflation curve, dealers said today, even after US CPI and PPI printed lower than expected this week.


    EUR 1y rose rapidly to finish at 7.125% (+16.5bps), moving back above 7% for the first time since the roll with September inflation already trading a touch above 10% in the reset market yesterday. EUR 5y moved further above 3% to 3.1125% (+9bps) but, as the curve flattened, 5y5y rose by just 2.5bps to 2.0875%. At the long end some small clips of 30y traded (link) and the swap rose to 2.475% (+4bps). 


    Traders cited the early strength of Brent and gas futures as factors, with oil testing $99 in the wake of US data yesterday pointing to a drawdown of gasoline inventories. Natural gas reached its highest level since late-July before paring gains into the close.


    Also of interest were reports about a new round of measures in Germany to protect households from the rise in energy costs. Chancellor Olaf Scholz today pledged additional assistance, especially for those “who have very little,” after Finance Minister Christian Lindner yesterday announced €10bn in income tax cuts to help consumers' purchasing power. Still traders today said there was uncertainty about how much higher energy prices would pass-through into German CPI, which was helping the front end of the curve.   


    Are real rates going high enough to get inflation down? DB  

    ECB officials face a difficult, uncertain balancing act when considering how much to tighten nominal and real interest rates. On the one hand, falling inflation could raise real interest rates. However, if inflation is falling does policy need to tighten much further? Deutsche Bank mulls real rates and concludes that the markets are not pricing enough tightening


      “Eurozone core HICP is currently at 4% and is expected to exceed 4.5% in Q4 versus ~1% in 2018 and a previous historical peak of ~2.5% in 2002. The market is currently pricing an ECB terminal rate around 1.25% (July-23 €STR) which is very similar to what 5y1y EONIA was pricing in 2018 (arguably a reasonable proxy for the terminal rate back then).”


      “Even if we assume that core HICP declines by 1% in H1-23, real policy rates would still be below -2.5%. Could such a low level of real policy rates be enough to bring inflation back to target?


      “Notwithstanding a very weak growth outlook, the answer is likely to be no given that (1) fiscal policy should be structurally easier in the years ahead and (2) political risk in Italy seems to be lower than feared a month ago and (3) the ECB has demonstrated its willingness to use PEPP reinvestments to support the periphery.”