Natural gas replaces oil as the "new powder keg" of inflation in Europe: gas storage at a five-year low, TTF nearing a five-month high, and the risk of central bank interest rate hikes reigniting.

As European natural gas prices approach a five-month high and gas storage levels drop to their lowest for this time of year in many years, bond investors and policymakers are shifting their main concern from oil to gas. Analysts warn that gas has a far greater impact on inflation in the Eurozone and the UK than oil, and with almost no fiscal policy buffering, it may force the European Central Bank and the Bank of England to reconsider their interest rate paths. Updated forecasts suggest that the overall inflation rate in the Eurozone will peak at around 4.2% in January 2027, significantly higher than current levels. Since the escalation of the US-Iran conflict at the end of February 2026, European natural gas prices have shown a marked divergence from oil prices. As of the time of writing, the near-month gas price at the Dutch Title Transfer Facility (TTF) has surged from around 32 per megawatt-hour at the end of February to 64, roughly double the level from a year ago; European gas prices are nearing a five-month high, with winter contract prices more than doubling compared to the same time last year. In contrast, Brent crude oil has risen from $71 per barrel before the conflict to about $86 currently. Although this is still more than ten dollars above pre-conflict levels, it has significantly corrected from its peak in the second quarter, approximately 30% lower than the highs prompted by the US-Iran war. This divergence is reshaping the risk pricing in the European bond market. Yields on 10-year government bonds in Germany and the UK have reached multi-decade highs, with market participants noting that gas has replaced oil as the most critical factor driving yields higher. Jamie Searle, a European rates strategist at Citigroup, stated, Gas prices have taken over as the key driver of yields. Since early July, duration has consistently followed gas prices, while attention to oil prices has diminished. He referred to the increased correlation between the 10-year benchmark bonds and gas prices. Emma Moriarty, a portfolio manager at CG Asset Management, also emphasized, Gas prices are more relevant to the UK and Europe and have not truly retreated under any ceasefire agreements; rather, they have continued to rise. The firm has increased its allocation of inflation-linked government bonds in its flagship multi-asset fund to nearly a record 49%, citing the rising risk of continuing price pressures. A potential energy crisis is forming in the gas market, and its inflation transmission far exceeds that of oil, wrote RBC Capital Markets strategist Megum Muhic and others in a report dated August 13. The "Oil-Biased" Fiscal Buffer Recent data show that inflation in the Eurozone rose from 2.8% in June to 2.9% in July, with the year-on-year increase in energy components accelerating from 8.5% to 10.3%. One key factor behind the rebound in energy inflation is the expiration of fiscal buffer measures previously deployed by various countries in response to rising oil prices. According to tracking by the Bruegel Institute, European countries have committed a total of 11.8 billion in fiscal spending to cope with energy shocks, with the largest single measures being reductions in fuel consumption tax and exemptions on electricity VAT, with over half of the measures not targeted at specific groups. Spain committed 4.7 billion, including 2.6 billion in tax cuts for fossil fuels and electricity, effective from March 21 to June 30; Germany's 1.6 billion energy tax reduction covered May and June; Italys fuel consumption tax cut for motor vehicles lasted from March to May; Ireland's measures extended to July. Most of the measures in Germany, Italy, and France expired by the end of the second quarter, while Spains fuel discounts were gradually reduced over the summer. The exit of these measures is directly reflected in the July data. Motor fuel prices in Germany surged by 23.0% year-on-year in July, precisely because the fuel discount ended on June 30; meanwhile, household energy prices fell by 1.4% year-on-year, still benefiting from residual relief measures. Eurozone energy inflation jumped from 8.5% in June to 10.3% in July, largely as a result of the tapering of fiscal buffers. In contrast, gas has received hardly any similar scale of fiscal protection. Europe's exposure to gas is primarily transmitted through price rather than quantity. More critically, the increase in gas prices is approximately three times that of oil, yet lacks corresponding policy hedges. Macro-economic and inflation forecasting company Turnleaf Analytics indicated in its August 18 forecast that as most oil-related relief measures have expired and remaining measures will gradually taper off, the impact of rising gas prices will become more pronounced in winter. The Hormuz Bottleneck and Storage Crisis In addition, the fragility of the European gas market stems from structural supply-side bottlenecks and insufficient storage buffers. The Strait of Hormuz typically accounts for about 20% of global liquefied natural gas (LNG) supply, and unlike oil, there are no alternative transport routes for gas, nor are there significant strategic reserves to absorb supply gaps. Since the end of March, QatarEnergy has suspended some exports due to force majeure, a pause that extends until October. Although Qatari gas accounts for less than 4% of the EUs total gas imports, the direct losses are limited; the issue lies in the fact that Asian buyers have absorbed over 80% of Qatar's export volumes, and they are currently competing with Europe for spot LNG in the Atlantic region. In the weeks following the conflict, Asian JKM benchmark prices surged by 51%, while the Dutch TTF rose by 35%, in contrast to a 9% decline in prices at the Henry Hub in the US. Europe does not heavily rely on Qatar physically, yet it is a price taker in this market. Weakened storage levels exacerbate the shock. As of April 1, 2026, EU gas storage facilities were only 28% full, the lowest level in four years; by early July, this had only recovered to about 49%. Gas storage levels reached 60% on August 13 and about 61% in mid-August, still the lowest for this time of year in five years. EU law requires storage levels to reach 90% by November 1, with a recommended minimum of 80% in difficult circumstances, and the lowest allowable ceiling set at 70%. To achieve the 90% target, LNG imports would need to be around 13% higher than in 2025, while Asia currently holds marginal price-setting power in the market. RBC strategists point out that even if there is a breakthrough in the Middle East situation and oil prices decline further, concerns over gas supply will continue to maintain pressure on interest rates. This creates an asymmetric risk distribution for interest rates: the upside potential is limited, while escalation of the situation implies significant downside risks, they wrote in their report. Turnleaf Analytics forecasts that overall inflation in the Eurozone will rise to around 3.4% in August and peak at approximately 4.2% in January 2027, before retreating to around 3.2% in April and stabilizing around 3.4% in July. This trajectory is driven both by gas and energy price levels and influenced by base effects. Energy inflation in the Eurozone will be negative each month from November 2025 to February 2026, with a year-on-year decrease of 4.0% in January 2026. Thus, even if energy prices remain stable in euro terms, the year-on-year increase will be pushed up by base effects in January, returning to positive growth after the base effect turns positive in March. Turnleaf noted that its August 18 forecast is about 0.3 percentage points lower than on August 3, primarily reflecting a drop in Brent crude prices, while gas prices have not declined in sync. From the composition of inflation, energys weight in the Eurozone HICP basket in 2026 is 9.0%, with the 10.3% energy inflation contributing approximately 0.9 percentage points to overall inflation. The services sector has a weight of 46.8%, with a year-on-year increase of 3.3%, maintaining between 3.0% and 3.5% over the past year; non-energy industrial goods account for 25.2%, with a 0.9% increase; food, alcohol, and tobacco account for 18.9%, with an increase from 3.2% in August 2025 to 1.2% in July 2026. These figures indicate that the Eurozone still faces significant relative price shocks, but core inflation has not fully absorbed the rise in energy prices. Turnleaf's contribution decomposition shows that the largest contributor to Eurozone trade energy prices is the near-month moving average of Dutch TTF gas prices, leading Brent crude prices, while the market-implied core CPI for the Eurozone also plays an important role in this model. Central Banks and Markets Face Asymmetric Risks This year, the European Central Bank has raised interest rates once, while the Bank of England has held steady. The money markets are currently pricing in one rate hike each for both banks before the end of 2026, followed by another before September 2027. However, several strategists believe that given the upward trend in gas prices and the lack of progress in negotiations over the Strait of Hormuz, these assumptions may need adjustment. Steven Barrow, head of G10 strategy at Standard Bank, stated, This latest inflation threat stems from difficulties in energy storage, combined with the impacts of summer heatwaves and droughts, leading us to be more cautious. We are prepared to revise our interest rate forecasts at any time. RBC strategists emphasized that even if a ceasefire in the Middle East pushes oil prices down, the issue of gas supply will still maintain pressure on interest rates, with risk distribution skewed toward the upside. Although the surge in bond yields is also driven by other factors, including unsustainable public finances, massive bond issuance by large cloud service providers, and unpredictable US policies, market participants believe that among energy-related risks, gas currently poses the greatest threat to interest rate prospects in Europe and the UK. The foreign exchange market is also beginning to reflect this risk. Strategist Adam Linton pointed out that the uptrend of the euro against the dollar may soon face resistance from high gas prices. Currently, the correlation between energy prices and the euro is not strong enough to assert dominance over the exchange rate, but as gas prices rise, this correlation is worth close attention. For Europe, the upcoming winter will be a crucial test. Weak storage buffers, absent fiscal protections, unresolved supply risks from Hormuz, and the potentially diminishing buffering role of renewables during peak winter demand and low output periods could pose significant challenges. The path for Eurozone inflation to peak at 4.2% in January next year is gradually becoming the baseline scenario that bond markets and central banks must confront.