Natural Gas, Not Oil, Is Key Inflation Concern in Europe

European policymakers and bond markets are currently more anxious about the surge in natural gas prices than the rise in crude oil futures, as the war in Iran has disrupted oil and gas flows. Natural gas prices in Europe have reached a five-month high, prompting energy-starved nations to seek out liquefied natural gas (LNG) supplies to fill storage facilities before the winter. Europe has fallen behind Asia in the competitive race for spot LNG supply amid the spike in prices, as Qatar's LNG terms have dwindled.

The situation is further exacerbated by Europe's struggle to replenish natural gas inventories in the spring and summer, as the country aims to build a reserve for the upcoming winter. Currently, storage levels are at 63% capacity, the lowest point in nearly two decades and below the five-year average. This shortage is likely to fuel inflation and trigger interest rate hikes beyond what is currently anticipated.

Yields on UK and German bonds in the European bond markets have soared to multi-decade highs, reflecting concerns over persistent inflation due to the surge in natural gas prices. According to Citigroup's European rates strategist, Jamie Searle, natural gas prices have become the primary driver of yields. CG Asset Management's portfolio manager, Emma Moriarty, adds that the natural gas price remains relevant to the UK and Europe, even as ceasefires continue, and has not recovered since the initial spike.

Higher energy costs have contributed to inflation in both the UK and the Eurozone, with July prices rising from the previous month and climbing compared to a year ago. The European Central Bank (ECB) is widely expected to raise interest rates again in September, but it may stop there. Analyst Charles Kennedy, writing for Oilprice.com, highlights the ECB's focus on maintaining control over inflation despite the current natural gas price surge.