Spike in gas prices puts central banks in an uneasy position

Highlights:

• The surge in gas prices has added to the hurdles of a recovery in advanced economies. Several factors lie behind the 350% surge in European gas prices since June, including lower inventories, past underinvestment (aggravated by the shift of capital to greener fuels), geopolitical issues and weather-related ones like the lack of wind limiting European renewables’ output. Some of them may not be resolved quickly, increasing the risk of persistently high gas prices.
• This not only has a direct impact on consumer prices, but also on the costs of several gas-intensive manufacturing sectors, leading to a more protracted fallout on prices. The result would add to the upward pressure from high non-energy commodity prices, spurred by undersupply.
• Switching from gas to oil can only help marginally, but would further put upward pressure on oil prices, on top of the impact of the recent decision by OPEC and Russia not to step up production above scheduled despite stronger demand. The role of US shale producer to rebalance supply has been weakened by tougher regulation and stretched balance sheets.
• The prospects of higher inflation and risks to growth leave central banks in a bind. A few have already cited higher inflation as a reason to tighten policy earlier than expected; however, a more fragile growth path may also induce caution. This difficult trade-off could spill over into higher inflation risk premia. Moreover, the risk of higher inflation and weaker growth is detrimental for both stock and bond prices, leading to a higher correlation, low diversification benefits and higher risk premia.
  
   

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