Macro Moments Weekly: How Inflation Lost its Oil Spark

Key takeaways:

• Oil price shocks are having less impact on inflation: Recent geopolitical tensions have lifted oil prices, but inflation in Europe and the US appears unlikely to experience sustained secondary effects.
• Europe’s economy remains weak: Falling demand, slowing hiring, declining vacancies and recessionary signals in services point to a disinflationary environment rather than a new inflation cycle.
• Markets may be shifting toward rate cuts: If inflation continues to fade, bond yields look increasingly attractive and broader equity markets could benefit from expectations of lower interest rates.

This week saw the resumption of hostilities between Iran and the United States, and with it a bounce in the price of oil. Other risk assets seem to have been less excited; after a small bounce, gold is barely changed. US Treasuries and Gilts did sell off amid the news, as did the US dollar. The markets seem to be looking through this because of the inflation data we now have.

Inflation in 2026 is looking like the dog in the night-time; it certainly has stirred, but it has not barked. In the United States, this is what we expected—we thought inflation would peak out quite quickly and other prices would not see a secondary reaction.

But in Europe, this was far from a certainty. In 2022, the inflationary impulse from Russia’s invasion of Ukraine came on top of an economy already experiencing price increases, as supply chains were struggling to refill and restock post COVID-19. In 2026, the situation is different. There are no supply chain disruptions, outside of the Strait of Hormuz. Manufacturing has reacted as if it were 2022, placing orders to “beat the price rises” even if they were not receiving many new orders themselves. This is a learnt reaction; it is possible that the manufacturing generals have made the mistake of learning how to fight the last war. How much stock will they end up with if demand doesn’t resume?

Construction is a sector armed with the hope of new government contracts for infrastructure projects. The problem is that these projects have not actually happened yet, and the sector remains in a job-shedding slump across Europe. Hardly a surprise after the rise in interest rates.

The service sector has reacted quickly, as it did in 2022, and reflected the immediate fall in demand. All the recent Purchasing Managers Index data across Europe indicates the sector is in recessionary territory. The strength of this collapse was not as great as 2022, but it has been widespread. A difficult combination of rising input prices and falling demand has also led to signs of employment cuts. All of which is deflationary.

What companies in all sectors have done, though, is be cautious about hiring, this is backed up by Hays PLC's results, showing that companies are switching from permanent hires to temporary ones. A classic recessionary response. At the same time, the number of vacancies has been falling. The risk of private sector pay rises—which would fuel second-round inflation effects—is diminishing, unless the public sector offers generous settlements to its workers. In the United Kingdom, public sector wages were rising in June at twice the rate of private sector wages. It cannot be sustained if inflation is to be subdued.

We cannot ignore the weather, either. A long hot spell in Northern Europe has led to falling high street sales, as Uniqlo confirmed this week. The World Cup has probably also provided a distraction for the consumer, with six of the eight quarter finalists coming from Europe.

So, if the breaking of the ceasefire creates further uncertainty, it’s unlikely that any inflationary impulse will last. In fact, there is likely to be a surprise to the downside, in particular as the vagaries of 2025 mean that food prices are likely to be no worse than flat in 2026.

The evidence is mounting that Europe will follow the US path of a short bounce in prices, as the oil price hike moves through. This looks done. The weakness of the economy, in particular in services, suggests that there will be little in the way of long-term secondary inflationary effects in Europe.

The recent selloff in Bunds, Gilts, OATs and Treasuries this week have made yields interesting. In equities, where artificial intelligence stocks continue to fly, we may find that the broader market gets more traction and will be led by value, as the prospects of rate cuts, and not rate rises, become clearer.

There is always risk—the most obvious would be for Europe that it fails to refill its gas storage over the summer, leading to fears of energy shortages in the winter and thus price spikes. We will know by September, less than seven weeks away.

Parting Shot

Back to the World Cup. We are now down to the last few sides, as of this writing. Of the quarter finalists, only England and Belgium have head coaches who are not nationals. The statistics are against them—no foreign coach has ever won the World Cup.