This article summarises a feature in Risk.net

Repeated energy shocks may be changing the distribution of inflation risk, but markets may not fully compensate investors for that uncertainty. New analysis of euro-area inflation swaps identifies when energy shocks are most likely to pass through and become persistent.

The analysis reveals that energy shocks do not pass into inflation in a simple, linear way. Using a time-varying analysis of euro-area inflation swaps and energy drivers, Samy Ben Aoun, Head of European Rates Trading, finds that short-term inflation expectations become considerably more sensitive when energy prices move into the upper part of their historical range. Natural gas is particularly important in inflation tail events, while the strength of demand determines how readily businesses can pass higher costs to consumers.

The duration of a shock is equally important. Distribution chains initially absorb higher costs through margins, but that capacity weakens as a shock persists. Producer-price inflation typically takes five to six months to reach food inflation and six to seven months to reach core inflation, creating a delayed transmission pipeline rather than an immediate response.

Repeated shocks could also point to a shift in the inflation regime. Since 2021, inflation outcomes have become more skewed to the upside, while forward curves continue to reflect assumptions developed during a period of relatively stable supply chains and largely transitory disruptions. As repeated supply shocks erode businesses’ capacity to absorb higher costs through margins, they may increase the likelihood that inflation pressures spread more broadly through the economy.

This raises a portfolio-pricing question. Nominal markets visibly compensate investors for duration uncertainty through term premia, but comparable compensation for inflation uncertainty is less apparent. The full paper examines whether repeated supply shocks could ultimately require a higher inflation-risk premium and what that could mean for the role of inflation-linked instruments in portfolio protection.