Natural Gas Prices Soar, Sparking Inflation Fears in Europe

The European natural gas market is facing an unprecedented crisis, with prices edging toward five-month highs and storage levels at their lowest for this time of year in years. This shift has policymakers and investors reevaluating their primary concerns from oil to natural gas.

As the eurozone's inflation rate rose to 2.9% in July, the energy component's year-on-year increase accelerated from 8.5% to 10.3%. The main factor driving this rebound is the phasing out of fiscal support measures that countries had previously introduced to cushion households against rising oil prices.

European gas prices are near five-month highs, with winter-contract prices more than twice as high as a year ago. By contrast, Brent crude has climbed from $71 per barrel before the conflict to about $86 today, remaining roughly 30% below the levels driven by the U.S.-Iran war.

The divergence in oil and natural gas prices is reshaping risk pricing in the European bond market, with yields on German and UK 10-year government bonds reaching multi-decade highs. Citi's European rates strategist Jamie Searle noted that 'natural gas prices have now taken over as the key driver of yields,' with a heightened correlation between the 10-year benchmark bond and natural gas prices.

The potential energy crisis in the natural gas market is exacerbated by structural bottlenecks on the supply side, including the Strait of Hormuz's limited capacity. Turnleaf Analytics forecasts that the eurozone's headline inflation rate will rise to around 3.4% in August and peak at approximately 4.2% in January 2027.