TTF natural gas futures have risen sharply, and the ECB is considering more interest rate hikes
European natural gas futures have exceeded the original forecast range. The increase in gas storage replenishment has driven the price up. The risk of energy inflation has risen, and the market is betting on further interest rate hikes by the ECB. The fluctuation of the TTF market has continued to expand.
The TTF futures have exceeded the forecast value.
The Dutch TTF natural gas futures are the benchmark contract in the European market. The European Central Bank previously set two scenarios for economic estimations. Under the base scenario, the TTF futures for December were estimated at 60.1 euros per megawatt-hour. Even in the adverse scenario, the highest estimate was 77 euros. Now the market price has exceeded 83 euros, largely higher than the worst-case scenario envisioned by the central bank.
Brent crude oil has risen above $107 per barrel, also exceeding the adverse assumption of the ECB. The rising oil and gas prices have led European policy officials to re-evaluate the inflation outlook. ECB member Schnabel publicly stated that one can not only focus on refined oil products such as crude oil, diesel and gasoline. The impact of these on inflation is also not to be underestimated.
The rise in natural gas futures stems from the replenishment pace of the European gas storage facilities. This summer, many European countries slowed down the injection rate of gas storage. At that time, the market was hopeful that the conflict in the Middle East would quickly subside and the gas price would fall, making it unnecessary to stockpile gas at high prices. The situation did not improve, and as winter approached, countries urgently increased the injection of gas storage. The concentrated purchase directly pushed up the TTF futures, and the price reached its highest point in four years.
The inflation risk is tilting upwards.
The focus of the market is gradually shifting from fuel to natural gas and electricity. Heating for households and electricity for factories will be linked to the TTF price. A rise in natural gas prices will be passed on to residents' bills, driving overall inflation. The potential for food inflation is also gradually emerging, which will further push up people's expectations for prices. The governor of the Latvian Central Bank believes that the conditions for continuing interest rate hikes are gradually maturing. Now, the key interest rate of the ECB is 2.5%. If it continues to increase, the interest rate will enter the range that inhibits economic growth. Interest rates do not have a fixed hard threshold. As long as the inflation risk continues to rise, interest rates can continue to increase.
Interest rate expectations will have an inverse impact on energy futures. If the ECB chooses to raise interest rates more, the overall demand in the eurozone will be suppressed, and in the long term, it will weaken the demand for industrial gas. Market pricing for the probability of an interest rate hike at the ECB's meeting on October 29th is 60%. Traders generally believe that the interest rate hike is likely to be implemented before the end of the year. The TTF contract volatility is moving back and forth with expectations for interest rates and the foreign exchange bond and energy futures markets respond.
Natural gas: disputes in the European market.
Following the escalation of the Russia-Ukraine conflict and the continuous expansion of new energy sources, various institutions have put forward different viewpoints. With the increase in renewable energy generation and the voluntary reduction in production by high-energy-consuming heavy industries, the overall demand for natural gas in the EU has declined. A similar increase in natural gas prices would have a smaller impact on the overall economy compared to a few years ago. The inflationary transmission effect brought about by the rise in TTF will weaken. If the transmission effect decreases, the ECB does not need to adopt aggressive interest rate hikes.
On the other hand, some believe that even if the total demand for natural gas decreases, the low level of storage facilities is a reality. Once severe cold weather occurs in winter, the demand for heating surges, and it is difficult to quickly fill the short-term supply gap. The transportation of LNG ships is tight, and it is difficult to quickly supply a large amount of additional gas sources to Europe. In this scenario, the near-month futures of TTF will continue to rise.
Natural gas is not the sole driver of inflation. The drought in the European region, combined with the global El Nino climate event, has disrupted agricultural production. The price of diesel and fertilizers has increased hiking the cost of farming. Markets are factoring in higher food prices over the next few months, adding to inflationary pressure. Even if prices of other commodities stay the same, the rise in food prices will heighten residents' inflation expectations.