Euro zone inflation risks stay elevated as ECB's Nagel flags limited second-round effects

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Highlights

Euro zone inflation stands at 3.8%, nearly double the ECB's 2% target, with Nagel warning that upward risks remain dominant.
Nagel highlights vulnerable gas prices due to low storage, refinery constraints pushing refined petroleum prices higher, and climate impacts driving food price risk.
Markets expect two to three ECB deposit rate hikes in the coming year, with rising yields making bonds more attractive and diversification into gold supported by geopolitical and credit risks.

Inflation outlook and policy signals

As reported by Reuters, Bundesbank President Joachim Nagel says euro zone inflation is high and that upward risks dominate, but costly energy has not yet triggered the second-round effects that central bankers fear could entrench faster price growth.

Speaking in Sorrento, Italy, Nagel says inflation in the 21-nation currency bloc is running at 3.8%, nearly double the ECB's 2% target, and could still rise further. He says there are so far no clear signs that inflation has fed through to price and wage setting, while longer-term market-based and expert expectations remain consistent with the Eurosystem's 2% inflation goal.

Nagel does not, however, signal that the threat has passed. He warns that price pressures are expected to remain strong even when volatile food and energy components are excluded, and says the ECB needs to stay flexible and continue making decisions based on incoming data rather than endorsing market expectations for future rate moves.

Energy, food and market implications

Nagel points to several factors that continue to threaten the inflation outlook. He says gas prices are especially vulnerable because storage levels are low and Europe may need to buy substantially higher volumes during the winter, while the loss of refining capacity is pushing up refined petroleum product prices significantly.

He also says drought, wildfires and fertiliser shortages pose additional risks to food prices, reinforcing concern that inflation could remain elevated across the region. Financial markets expect the ECB to raise its 2.5% deposit rate another two or three times in the coming year after two increases this past summer, while LSEG data show markets are pricing in a 20% chance of a rate hike in October and an 80% chance in December.

On financial markets, Nagel says rising yields are increasing the relative attractiveness of bonds for reserve asset managers. At the same time, he adds that the case for diversification into gold remains significant because of continued geopolitical stress and credit risk linked to high debt levels.

In our earlier article, we covered how the euro came under renewed pressure as investors focused on France’s fiscal strains and widening French-German bond spreads alongside still-elevated U.S. Treasury yields. We noted that the common currency slid to a multi-month low, with concerns that stress in French markets could spill over more broadly across Europe.

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