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Euro and sterling set to come under further pressure

euro notes with a red down arrow

Just when you think the outlook can’t get any worse, gas prices have continued to surge this morning after the news over the weekend that Russia will once again be closing Nord Stream One for “maintenance” for 3 days at the end of the month.

This continued weaponization by Russia of its gas pipeline is not only driving gas prices ever higher, but it’s also pushing up the price of coal, as well raising concern that this will be an ongoing theme as we get closer to the winter months.

It matters little whether Russia will decide to cut off flows completely the market is behaving as if they will, prompting a consistent narrative of where inflation is likely to be this time next year, as consumers get set to bear the brunt of the complete failure of European and UK energy policy of the last 20 years.

The continued warnings that the phasing out of nuclear power in Europe, and Germany especially were ignored, and in fact were dismissed, has been exposed for the utter folly that it is. When combined with the lack of investment into alternatives, while also cutting back on oil and gas capacity, Europe, and the UK appear woefully unprepared for the inflation wave coming its way.     

This morning US bank Citigroup became the latest institution to play the latest game of "how high can UK inflation go" as economic research departments try to outdo each other in the headline numbers stakes.

The latest estimate is now for UK inflation to rise to 18.6% in January next year due to the rise in gas prices, and the resultant forced increases in the energy price cap.

As can be seen from the chart below UK natural gas prices for September settlement have almost trebled since May, while those in Europe have risen by 350%, from lows of €78.60 in June to be trading at €282 today.

UK Natural Gas prices (September)

Source: CMC Markets

While inflation here in the UK already above 10%, the situation in Europe appears to be an order of magnitude even worse given that countries like Germany and Italy look to try and replace their exposure to Russian gas.

Even without the problems of high natural gas prices, the strength of the US dollar is compounding the issues facing the UK and Europe as it pushes up to multiyear highs against the euro and the pound. This has the effect of keeping upward pressure on inflation as the weakness of the pound and the euro makes it all the more difficult to contain upward pressure on prices.

We have seen some respite on food prices which have fallen back from their peaks this year, while the decline in Brent crude has also brought petrol prices down, however there is no escape from the insidious nature of the rise gas prices which is ramping up the costs for business and consumers alike

Could inflation in the UK rise above 18% by the beginnng of next year? It’s certainly possible, but it also assumes that the government won't act to contain the tsunami of consumer fury coming its way, which seems unlikely, although whether it will be enough is another matter. 

Certainly the outlook for the euro and the pound looks bleak, with the euro set to move below its lows this year, and head towards 0.9620, as previously warned earlier this year.

As for GBP/USD, the outlook here also looks perilous with a break below the July lows of 1.1760, opening up the lockdown lows of March 2020 around the 1.1500 area.

EUR/USD monthly chart – targeting 0.9620 and possibly lower

Source: CMC Markets

With Fed Chair Jay Powell due to speak later this week at the Jackson Hole symposium, its highly likely that he will lay out a path for at least another 150bps of rate rises by year end, putting the Fed funds at 3.75% to 4%.

This in turn will increase the pressure on the Bank of England to raise rates by 50bps in September, and perhaps more by year end.

Can the ECB do the same without upending the European bond market, and potentially manage any spike and widening in yield differentials.

It seems highly doubtful given that their new TPI Transmission Protection Instrument is untested and could be challenged in the German courts, which means further euro downside looks inevitable, as recession comes knocking, if in fact it isn't already here. 

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