Exploring the interplay between eurozone electricity sector stocks, real interest rates and inflation expectations

This paper examines the relationship between Eurozone electricity sector portfolios and interest rate changes from 2019-2022 using quantile regression. We distinguish between changes in nominal interest rates caused by changes in real interest rates and those caused by changes in expected inflation. A new feature is the used of inflation-linked swaps to measure inflation expectations. This decomposition provides a richer view of how variations in nominal interest rates affect electricity portfolios. It indicates that real rate changes significantly impact electricity stock returns, while nominal rate changes due to variations in inflation expectations have a smaller effect. The research splits the sample period into two subperiods: a stable period (2019-2020) and a volatile period (2021-2022). Note that an initial training period to calibrate the electricity portfolio optimization approach (January 2015 - December 2018) is also included. We also distinguish between companies based on their debt levels. Our findings support the hypothesis that the European electricity sector is significantly exposed to interest rate changes, with notable differences depending on companies leverage. The impact of interest rate changes on electricity portfolio returns is more pronounced during extreme market conditions, such as bearish market states. However, quantile regression analysis suggests that in certain scenarios, electricity companies can pass on some inflationary shocks to their product prices, particularly during bullish market states. • Relationship between portfolios in the euro area electricity sector and interest rates. • This study applies the quantile regression approach. • A distinction is made between two sub-periods (stable and volatile) and between two portfolios with different debt profiles. • It decomposes nominal interest rates into real interest rates and expected inflation rates. • The impact of interest rate changes varies according to debt profile and time period. • Extreme market conditions amplify the impact of interest rate changes on electricity portfolio returns. • Electricity companies can pass through inflationary shocks to prices in bull markets. • Negative relationship between electricity portfolio returns and real interest rates found.