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Theme · past 6 monthsUS, UK, Euro area, Japan

Oil’s second wave and the second-round test

Oil’s second wave pushed headline inflation up again; the front end now trades on whether it spreads into pay and services.

What it did to the curve

Front end

Yields higher

2-year

Long end

Yields higher

10–30-year

Curve

mixed

long minus short

Inflation risk lifted long yields everywhere: from mid-April to 16 Oct the 10-year rose about 78bp in the US, 55bp in the UK and 40bp in Germany, and the JGB 10-year hit 3.055% on 24 Sep, the highest since 1996. Curve shape split by central bank: flatter where hikes led (US and German 2s10s), steep in Japan, where 2s10s was about +110bp at the end of September.

Brent crude

$109.86

up+$36.10

16 Oct settle, the highest since May, up from $73.76 on 25 Jun.

Euro-area inflation

3.8%

up+0.6pp

September flash: energy +18.8% but core only 2.5%, so the second-round test is still ahead.

UK CPI

3.1%

up+0.5pp

August, from 2.6% in June; the BoE path Lombardelli cited is about 3.7% in Q4 and about 4.2% in Q1 2027.

US CPI

3.7%

up+0.3pp

September, from 3.4%; core was 2.6%, but producer prices rose 6.3% y/y.

What happened

In mid-April a ceasefire had pulled oil below $100. Then came two waves. Brent topped $126 on 30 April, then fell to $73.76 on 25 June after a US–Iran deal to reopen Hormuz. It climbed again once the truce collapsed in July, settling at $109.86 on 16 October.

Brent stayed high even though crude flows through the held at about 10–12mb/d, against 17mb/d before the war. With 26 vessels struck in October, the price carries a for flows that could still be lost.

A hits headline inflation first. Euro-area inflation reached 3.8% in September, with energy up 18.8%. UK CPI rose from 2.6% to 3.1% in August. US CPI reached 3.7% in September.

Front ends rose with hikes, and long ends with the risk that inflation lasts. The test now is : energy feeding into pay and services, so inflation persists after oil stops rising. inflation, which leaves out energy and food, is lower so far: 2.5% in the euro area, 2.6% in the US. Lagarde said on 14 October the ECB saw no significant second-round effects yet, and Bailey saw little evidence on 16 October.

Others are less sure. Greene says UK pay near 3.5% is too fast for 2% inflation, and Lagarde said on 17 October the shock was too large to look through, or treat as temporary. Ueda said Japan’s underlying inflation is near 2% and must not accelerate further. The UK, with firm pay and a BoE path above 4% in early 2027, is the front end most exposed if pass-through sticks.

Timeline

  1. Brent briefly tops $126, a wartime high, as stalled talks cast doubt on reopening Hormuz

  2. Brent falls to $73.76, the lowest since before the war, after a US–Iran deal to reopen Hormuz

  3. By mid-July the truce has collapsed: the US steps up strikes on Iran after reimposing its naval blockade

  4. · UK

    UK August CPI 3.1%, the first reading above 3% since March, with motor fuel up 23%

  5. · Euro area

    Euro-area September flash inflation 3.8%, with energy up 18.8% and core 2.5%

  6. · US

    US September CPI 3.7% y/y, core 2.6%

  7. Brent settles at $109.86, the highest since May; Bailey sees little evidence of second-round effects

What could change it

Base case

Oil stays high but flows hold. Headline inflation peaks around the turn of the year (the BoE path Lombardelli cited reaches about 4.2% in Q1 2027) while core stays contained, so central banks add one more hike rather than a series.

Watch: UK CPI, 21 Oct · ECB, 29 Oct · BoE, 5 Nov

Second-round risk

Pay and services pick up, as Greene fears, and core follows headline. Markets price a series of hikes, lifting front ends. Renewed US strikes after the midterms, which Trump has reportedly told aides he expects, could push Brent higher; some bank scenarios see above $120 if attacks persist.

Watch: UK CPI, 21 Oct · US PCE, 29 Oct · US midterms, 3 Nov

Relief rally

A Hormuz deal pulls oil lower (Iran says the strait could reopen within six days if the US accepts its terms). With core contained, headline inflation falls back and front ends price out hikes. Goldman’s base case is Brent at about $80 in Q4.

Watch: ECB, 29 Oct · BoJ, 29–30 Oct · FOMC, 9 Dec

How desks express it

BoE second-hike spread

Spread

Receive Nov, pay Feb 2027 meeting-dated SONIA OIS

If UK pay keeps inflation sticky, November is the first BoE hike of a series, not a one-off.

  1. 1

    Greene says pay settlements near 3.5% are too fast for 2% inflation, and she has voted to hike at each of the last three meetings.

  2. 2

    The BoE path Lombardelli cited has CPI at about 3.7% in Q4 and about 4.2% in Q1 2027, after the November meeting.

  3. 3

    November is mostly priced (about 83–91%), so the next repricing is in the meetings after it; BofA and Citi both forecast a February 2027 hike.

Wrong if: Pill said a hike need not start a long series and pushed back on pricing of four rises over the next 12 months, and Bailey sees little evidence of second-round effects. A soft UK CPI on 21 Oct or one-and-done guidance on 5 Nov would narrow the spread.

Euro front-end receiver

Outright

Receive 1y €STR OIS

If euro-area core stays near 2.5%, the ECB can stop at 2.50% and the hike priced by December comes out.

  1. 1

    September’s 3.8% was driven by energy (+18.8%); core was 2.5%.

  2. 2

    Lagarde saw no significant second-round effects on 14 Oct, and on 17 Oct said higher long-term rates will slow growth and limit pass-through more than projected in September.

  3. 3

    Money markets near-fully price a hike by December, so a pause would pull 1-year rates lower.

Wrong if: Services inflation rose to 3.2% in September, Nagel can’t rule out another hike, and the IMF expects at least one more 25bp ECB hike this year. A hawkish ECB on 29 Oct, or Brent pushing higher, would hurt.

Educational expressions of the theme — how a desk might position, not advice.

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