Faster gas price impact adds to ECB's inflation worries

Energy prices rose sharply in the second quarter of this year, inevitably sparking fresh comparisons with the 2021-2022 energy shock.

Although the ECB says the current shock is different in nature from the earlier one, the central bank's latest economic bulletin highlights a notable detail: changes in wholesale gas prices may now transmit to euro area consumer inflation more quickly than before.

According to the ECB's survey of national central banks, for over half the euro area, wholesale gas price movements are projected to show up in HICP gas inflation within one to three months. In 2022, a considerably larger portion of that pass-through took more than a year.

Why is this important?

The importance stems from the awkward inflation backdrop the ECB is already facing.

Earlier this month, the central bank adjusted its policy stance by raising key interest rates by 25 basis points, as the Middle East conflict and energy shock lifted its inflation projections. Policymakers have also warned that they are monitoring not just the initial energy impact but its indirect and second-round effects.

One should not interpret the ECB's latest research as automatically pointing to much higher inflation and consequently another rate hike. ECB President Christine Lagarde has already rejected the notion that interest rates move in lockstep with energy prices, as noted in this article.

Nevertheless, the bulletin suggests that the window policymakers have to determine whether a gas price spike is temporary might be shorter than anticipated.

That makes the next few euro area inflation releases especially critical. Markets should watch whether higher energy costs remain confined to headline inflation or begin to bleed more visibly into services, goods prices, and inflation expectations.

Eventually, wage growth figures will also come under increased scrutiny. If firms face higher energy bills while labour costs stay elevated, the ECB will be much more alert to evidence that businesses are passing on those costs.

For the rates market, the equation has not really changed. Higher gas prices alone are only the first part of the story. The bigger question remains whether the shock starts altering the trajectory of underlying inflation.

But with this latest information, the timing for deciphering the full equation may have shifted slightly. No longer might it require waiting a year; the answer could come within the next few months.

So if that happens sooner rather than later, markets may have to reprice their ECB outlook much faster than before.