Faltering inflation in the eurozone pits the European Central Bank against the markets

Faltering inflation in the eurozone pits the European Central Bank against the markets

  • Inflation at 2.4% in November compared to 2.9% in October
  • Markets are betting on interest rate cuts in April
  • Core price growth is also down

FRANKFURT (Reuters) – Euro zone inflation fell more than expected for a third straight month in November, challenging the European Central Bank’s narrative that price growth is stubborn and fueling bets on early spring interest rate cuts in defiance of the bank’s explicit guidance.

Inflation has fallen rapidly towards the European Central Bank’s target of 2% from levels above 10% just a year ago, but policymakers have warned against excessive optimism. They warn that the “last mile” of fighting inflation could be more difficult and take twice as long as it would take to return to below 3%.

Actual data showing inflation falling much faster than expected appears to challenge these expectations, even if a bounce back in the coming months is still possible as higher energy prices emerge from the previous year’s numbers and some tax cuts are reversed.

Consumer price growth in the 20 countries that use the euro fell to 2.4% in November from 2.9% in October, well below expectations of 2.7%, affected by almost all components, with the notable exception of unprocessed food prices.

Even core price pressures eased more quickly than expected, with inflation excluding food and energy – closely monitored by the ECB – falling to 3.6% from 4.2% due to a large decline in services prices.

The rapid deceleration of inflation puts the eurozone central bank and investors on a collision course, as the two appear to see vastly different paths ahead, both for consumer prices and ECB interest rates.

“With a third month of unambiguously good inflation reporting, and with prices actually lower than the previous month, it looks like we will soon be talking about inflation being too low, not too high,” said Camil Kovar, an economist at the European Central Bank. said chief economist at Moody’s Analytics.

“If recent trends in inflation and growth continue, 2024 will be the year the ECB implements a monetary policy rotation.”

The ECB believes that fundamental dynamics are more stubborn than they appear and that inflation will actually return to above 3% next year, and will not reach the 2% target until late 2025, partly due to rapid growth in nominal wages.

This would require the bank to keep the deposit rate at a record high of 4% for an extended period, and even Yannis Stournaras, head of the Greek Central Bank, does not see any cut before mid-2024.

New data released on Thursday shows that unemployment has remained at a record low of 6.5% despite the economic downturn and appears to support this argument as it underscores how tight the eurozone labor market is.

Bank of Italy Governor Fabio Panetta did not explicitly back down from the European Central Bank’s guidance on Thursday, but warned of the risks of keeping interest rates high for too long.

“The duration of this phase will depend on the development of macroeconomic variables; it may be short if continued weakness in economic activity accelerates the decline in inflation,” said Panetta, a former member of the European Central Bank’s Governing Council. “We need to avoid unnecessary damage to economic activity.”

Investors are increasingly ignoring ECB President Christine Lagarde’s explicit guidance on fixed interest rates for several quarters, with cuts priced in at a combined 115 basis points for next year, with the first step set to take place in full by April.

One of the main reasons behind this discrepancy is that the ECB’s forecasts have a poor track record. Several times in recent years it has had to abandon its guidance after initially falling short of market expectations.

Economists say growth is weaker than the European Central Bank expected, the labor market is softening, and demand for credit has evaporated, all of which point to a rapid decline in inflation.

“Also, there is still a lot of tightening impact ahead as interest payments continue to rise,” ING economist Bert Cullen said. “So the market is right to start looking at interest rate cuts for 2024. We think the first cut could happen before the summer.”

Some economists argue that modeling current inflation is extremely difficult because corporate profits are the main driver, not wages as in normal bouts of rapid inflation.

Balazs Kourani reports; Edited by Catherine Evans

Our Standards: The Thomson Reuters Trust Principles.

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