Is 2017 The start of the Inflation Game?

It is only the start of 2017 and already analysts are questioning what the impact of higher inflation will be.

With preliminary year on year inflation figures for Germany jumping from 0.8% in November to 1.7% in December and Eurozone inflation rising from 0.6% to 1.1% the ECB are now in a difficult situation. The current rise in inflation has been linked to the rise in energy, with Crude Oil futures trading above $53.00 a barrel at the time of writing. And with the OPEC production cut only just starting to kick in, we can anticipate some further bullish momentum when it comes to the black stuff.

With ECB President Mario Draghi having only recently said that tapering the current bond purchasing program was not discussed at the last ECB meeting, it is anticipated that this view point may need to change if inflationary trends continue. After all, the Eurozone economy is starting to see the uptick in prices that the central bankers have been trying to engineer all this time.


2016 EU Inflation



Of course, this is still some way from the ECBs target inflation rate of close to 2%, but if 2017 continues where 2016 left off, then this won’t be too far away. It will take some time to reel in the large amounts of spending, but traders will now be expecting the rhetoric from the ECB to begin to change.

If we keep in mind that currently the Euro is trading at €1.04 against the dollar, there is risk of a fall towards parity should there be any signs of weakness in the Eurozone recovery. Whereas the ECB’s case for a weakened Euro to stimulate inflation and boost exports is valid, any benefits this may bring could be quickly undone if the Euro begins to fall uncontrollably. It will be interesting to see how exactly Mario Draghi and the ECB tackle this, with their next scheduled monetary policy meeting on the 19th of Jan.

So is this all because of that US Election thingy??

By the looks of it, no. It’s quite possible that the amount of event risk in 2016 took everyone’s eyes off the data points for a while, but inflation has been creeping up across the globe …even in Japan!

The culprit, in no small part, has been the price of oil – which has been on fire since February 2016’s lows of $26.00 a barrel, to where they are now, comfortably over $50.00.

The below chart gives a good insight into this. Through the latter half of 2016 we can see the price of oil and the yield of the US 10 Treasury Note increase in tandem. The sudden surge in yield in November of course coming off the back of the US election result, but we can see that the two have experienced a certain level of correlation.


10 year yield vs. crude oil futures



So what does this mean going forward?

If we continue to see the rise in oil, and the associated impact on consumer prices, then we are likely to see the continuation of yield rises. Some would argue this is long overdue given the distorted pricing of bonds as a result of various bouts of QE. Either way it seems the bears are gathering outside the doors of the bond bulls.

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