Commerzbank Analyzes the Interconnection of Inflation, Oil Prices, and Interest Rate Expectations
Recent analysis by Commerzbank highlights the intricate relationship between inflation expectations, oil prices, and interest rate forecasts in the euro area. Inflation expectations have seen a significant decline, with market predictions dropping to just over 1.5% for the next year, which is considerably below the European Central Bank's (ECB) target. However, this dip is likely to be temporary, as expectations have recently adjusted back to levels observed at the end of August, according to Michael Pfister, FX analyst at Commerzbank.
The recent surge in oil prices, which increased by nearly $8 per barrel due to escalating geopolitical tensions in the Middle East, is a primary driver behind this correction in inflation expectations. The correlation between rising oil prices and inflation is well established; as oil prices climb, inflation typically follows suit. Currently, oil prices have returned to levels seen at the end of August, reinforcing this connection.
While interest rate expectations have also seen adjustments in recent days, this movement did not coincide with the spike in oil prices. Instead, interest rate forecasts remained stable during the oil price increase, only shifting after the unexpected payroll figures released on Friday. This led the market to eliminate the possibility of a 25 basis point rate cut. However, this adjustment primarily influences long-term rates, while the base case for the next two to four meetings still suggests potential rate cuts at each meeting.
It is important to note that the rise in inflation expectations was not a direct result of the payroll figures but was instead driven by the fluctuations in oil prices. Concurrently, the adjustments in interest rate expectations were influenced more by the U.S. payroll data than by rising inflation. The current market sentiment indicates a belief that the real economy, rather than inflation metrics, will play a crucial role in determining future interest rate cuts.