The nasty penalties of pure gasoline value volatility | USAEMALL.com

The rupture in the transatlantic security alliance over the past few weeks is leaving Europe with some unpleasant choices. After any ceasefire arrangement between Russia and Ukraine, should the continent return to buying gas from Moscow using a Baltic pipeline with US blessing, as the FT reported over the weekend? Alternatively, should it seek to wean itself off dependence on any Russian fossil fuels?

For Europe, the economic questions regarding natural gas are as difficult as the strategic issues. The natural gas price shock of 2022 following Russia’s invasion of Ukraine was the primary force behind Europe’s great inflation. Worse, as importers of gas, European nations automatically become poorer if energy prices rise and no one enjoys the fights involved in distributing the losses. Energy prices are also some of the most salient for consumers and companies, so rises in gas prices threaten the stability of inflation expectations and are likely to foster higher wage demands, keeping inflation higher for longer.

Since 2021, the rise in European gas prices made some industries uncompetitive, such as bulk chemical and fertiliser production, amplifying the need for economic restructuring. In this context, three years of German economic stagnation was a creditable outcome, Erik Nielsen of UniCredit convincingly argued at the weekend. There is no doubt that gas matters. So what is happening in this market?

First, the good news. As the chart below shows, gas prices in continental Europe are nothing like as high or volatile as they were in 2022. The wholesale price on Monday of around €46 per megawatt hour is more than double the pre-2022 price, but also way down on the crisis costs soon after Russia’s assault on Ukraine.

The bad news is that European wholesale gas prices have nearly doubled over the past year, raising heating and electricity costs for households and companies alike. Energy prices are again pushing inflation higher.

The chart below shows that European prices have come down about 20 per cent compared with the recent peak on February 10. Worse news is that they have risen more than 10 per cent since a recent trough last Wednesday, February 26. Volatility is, therefore, still high.

The chart is doubly useful because it compares wholesale prices in the same units and currency (€ per MWh) across the Eurozone, UK and US. It demonstrates that Europe now in effect has a unified market with the UK, with price trends and levels almost identical to those on the continent over the past year.

The same is far from true with the US. Although American wholesale prices have also doubled, the cost of wholesale natural gas is less than a third of that in Europe.

Given this differential, there is no doubt that, when it comes to negotiating with President Donald Trump, Europe should offer to buy more US liquefied natural gas. Since it is far from clear that Trump knows its price or that these are private markets where governments have limited powers, Europe should also offer to purchase at a comparatively generous premium.

The faster Europe can boost its LNG import capacity, the quicker it can diminish its gas price disadvantage with the US, increase imports from the US and reduce its bilateral trade surplus in goods. That is entirely in European interests and might please Trump, even though narrowing the gas price differential between the US and Europe does not necessarily benefit the US.

Apart from a doubling in price, another problem in wholesale prices in Europe has been some troubling trends in futures prices, raising the expected cost of gas this summer (2025) compared with next winter (2025-26). The problem is that a winter price premium is needed to provide incentives to replenish European gas storage when heating is not needed in the summer.

Since late last year there has been a summer price premium, discouraging traders from buying gas this summer to put in storage and sell next winter, as the chart below shows. Normally prices in winter are about 10 per cent higher than in summer.

That said, as we are getting to the end of a colder than usual European winter, storage levels have fallen, but we should not get alarmed. This year gas storage in Europe is down significantly on last year, but not much below the average level between 2011 to 2025 for this time of year.

Until the winter price discount disappears, storage is unlikely to fill quickly. We should also remember that storage is not everything. It represents only about a third of EU annual gas consumption. The price mechanism is likely to resolve these temporary difficulties in boosting storage, albeit potentially at the cost of higher gas prices next winter.

The immediate question is what this means for inflation and interest rates in Europe. The near doubling of gas prices over the past year has removed the pleasant downward force on annual inflation rates, replacing it with something much less benign, pushing inflation higher across Europe compared with autumn last year. Headline inflation has risen above the 2 per cent target in both the Eurozone and the UK.

For the Eurozone the immediate question this week is what gas price assumptions the European Central Bank will include in its new forecasts, published on Thursday. The previous forecast was based on a gas price in the mid-€40s per MWh and gradually declining, which is similar to today’s futures prices. The ECB convention is to take average futures prices for gas over 10 working days with a cut-off roughly three weeks before the meeting.

That would put the assumed gas price close to the recent peak, around 15 per cent higher than they are today and 22 per cent higher than assumed in the December forecasts. The ECB’s calibration of this difference from its last forecasts is that the change would add roughly 0.6 percentage points to 2025 forecast inflation and 0.4 percentage points to 2026 forecast inflation. Do not be surprised, therefore, if the ECB’s inflation outlook is bad on Thursday. The fall in the gas price since early February implies reality is not as difficult.

The Bank of England recently forecast that higher energy prices would add 0.4 percentage points to UK inflation by the summer, with CPI inflation rising to 3.7 per cent. The chart below shows that on February 26, gas prices had fallen back to the levels in the BoE’s previous forecasts from November 2024 and would have removed the entire 0.4 percentage point uplift. Gas prices have risen since, but not back to the level in the monetary policy report.

This demonstrates the importance of gas prices for Europe and how no one can have a good forecast for headline inflation when the wholesale price remains volatile.

(Re) defining data dependence

ECB officials have been having fun defining the concept of data dependence.

The common understanding of “data dependence” had been that central bankers were opting to look more at published data, especially inflation figures, rather than their models because these had become unreliable. This was inevitably backward looking, since inflation data is published with at least a month’s lag.

ECB President Christine Lagarde introduced the concept of data dependency in March 2023 as a response to an “elevated level of uncertainty”. At the time, she said monetary policy would be set from that time forward on the basis of the ECB’s “assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission”.

It was clear that the “dynamics of underlying inflation” meant various measures of core inflation and was backward-looking, otherwise the first two of the three prongs would be tautologous. Of course, this backward-looking data had relevance for the future. That was the point. Policymakers thought it had more relevance than their models.

All this was well understood, but recently ECB executive board member Isabel Schnabel and Finnish central bank governor Olli Rehn have attempted to say data dependency always was and will only ever be a forward-looking concept. “I never saw data dependence as a backward-looking concept. It was always forward-looking because we use incoming data to learn more about the credibility of our inflation outlook,” Schnabel told the FT.

It is clear that the credibility of central bankers matters. But Schnabel is testing that very credibility by saying that data dependence was always and only a forward-looking concept. Indeed, the “robust control” policy Schnabel favoured in 2022, suggested reacting more strongly with interest rates to high inflation even if that carried risks for the future. You can make an argument that was also forward-looking, but the logic is pretty convoluted.

As ECB chief economist Philip Lane told the FT — in my view with more historical accuracy — the challenge for the ECB as inflation comes down is “making a transition from a backward focus to a forward-looking focus”.

What I’ve been reading and watching

• If you want the latest information on tariffs (as far as anyone knows), read Alan Beattie’s Trade Secrets newsletter. You’ll find all the important trade consequences there. You won’t find what is going to happen because no one knows

• Whoop whoop, Turkish inflation has fallen below 40 per cent. Seriously though, orthodox economics, including a policy rate of 45 per cent, has been working

• The failure of G20 finance ministers even to produce an empty communique demonstrates the lack of co-operation in global economic affairs (and the irrelevance of the G20)

• This time next week, the showdown between former Bank of England governor Mark Carney and my former colleague Chrystia Freeland to become the next Canadian Liberal party leader will be resolved. Trump has made them both more popular than thought possible before he entered the White House

A chart that matters

Economic models can give nonsense results. An example came last Friday when the Atlanta Fed’s excellent GDPNow model said its forecast for US annualised growth in the first quarter had plunged from a rate of 2.3 per cent to minus 1.5 per cent and then dropping further to a rate of -2.8 per cent yesterday.

The proximate cause was a surge of goods imports ahead of prospective tariffs. Because imports subtract from GDP, the model interpreted the move as negative for output. The truth is that these imports will be offset by a surge in stockpiling, which is unusual and positive for GDP.

There is little doubt that Trump is harming the US economy, especially with his imposition of tariffs on Canada and Mexico today. But that does not mean the model is correct. It assumes the surge in imports is negative for growth because that is normally true and would have been true in the data on which it was estimated.

We know better. The US economy might be faltering. But do not be fooled that it is slumping.