Bond investors are grappling with rising inflation fears as energy prices surge across Europe and the UK. While inflation-protected bonds may offer some security over time, they can still decline sharply in market downturns. Natural gas prices in Europe have doubled, creating significant inflation pressure that differs markedly from the relatively stable US natural gas market.

Energy price shocks are now being priced into inflation markets, with UK and European short-term inflation expectations rising more sharply than in the US. The divergence stems from Europe's heavier reliance on natural gas and the region's policy responses to the price shock. Breakeven inflation rates from UK and US swap curves show markets expect the energy crisis to hit UK households and policymakers harder than their American counterparts.

European inflation-linked bond markets present a complex picture due to varying credit risks across German, French, and Italian government bonds. Despite shallower liquidity compared to UK and US markets, inflation expectations have risen sharply, particularly at the short end of the yield curve. The unanchoring of inflation expectations post-Covid has traders reducing their forecasts for rate cuts this year, reflecting growing concern about persistent price pressures.