European shares surge as oil retreats, inflation caution remains

European equities are enjoying a broadly positive session on Tuesday, with rising confidence pushing markets higher. The retreat in crude prices, driven by hopes of a de-escalation in US-Iran tensions, is helping investors move past last week's unease. The gains seen on Monday are continuing into the new trading day, with most major benchmarks posting substantial advances.

• Eurostoxx +1.1%
• Germany DAX +1.2%
• France CAC 40 +1.2%
• UK FTSE +0.7%
• Spain IBEX +1.2%
• Italy FTSE MIB +1.3%

European stock markets are displaying a broad green sweep, with most key indices climbing more than 1%. Cheaper oil is providing some relief for the inflation outlook, a factor especially relevant for Europe given its reliance on energy imports. This is prompting investors to reconsider the economic fallout from the recent energy price surge seen in recent months.

That said, caution is warranted before embracing the upbeat mood too fully. While declining oil prices may ease some inflationary pressure, it does not signal that the broader problem has disappeared.

With the US CPI release scheduled for later today, markets may face another sharp reminder of how much work remains for central banks.

Headline inflation is forecast to ease to 0.3% month-on-month in October, compared with 0.6% in September. Core inflation is projected to slow to 0.2% month-on-month, down from 0.3% previously. The probability of another Federal Reserve rate hike in December is still priced at roughly 84%, leaving little tolerance for an upside inflation surprise.

For European equities, the main risk may not be the inflation data itself but rather the reaction of US Treasury yields. A stronger-than-expected report could push yields higher, reignite concerns about tighter financial conditions and dampen the rally in stocks. Conversely, softer inflation combined with falling oil prices could give buyers further reason to sustain the recovery.

For now, dip buyers remain in control. But with the US CPI report still to come, there is ample reason for markets to exercise caution.