People shop at a market in Frankfurt, Germany, on Sept. 28.Michael Probst/The Associated Press
Euro zone inflation tumbled more than expected for a third straight month in November, challenging the European Central Bank’s narrative that price growth is stubborn and fuelling bets on early spring rate cuts in defiance of the bank’s explicit guidance.
Inflation has dropped quickly towards the ECB’s 2 per cent target from levels above 10 per cent just a year ago but policy-makers have cautioned against excessive optimism. They warn that the “last mile” of disinflation could be more difficult and take twice as long as getting back under 3 per cent.
Hard data showing inflation falling much faster than expected appears to be challenging that outlook, however, even if a bounce back in the coming months is still likely as high energy prices get knocked out of year-earlier figures and some tax cuts are reversed.
Consumer price growth in the 20 nations sharing the euro currency dropped to 2.4 per cent in November from 2.9 per cent in October, well below expectations for 2.7 per cent, dragged lower by nearly all items, with the notable exception of unprocessed food prices.
Even underlying price pressures eased more quickly than forecast, with inflation excluding food and energy – closely scrutinized by the ECB – dipping to 3.6 per cent from 4.2 per cent on a big drop in services prices.
The rapid inflation slowdown puts the euro zone central bank and investors on a collision course as the two appear to see greatly different paths ahead, both for consumer prices and ECB interest rates.
“With a third month of an unambiguously good inflation report, and with prices actually declining from the previous month, it is starting to look that before long we will be talking about inflation being too low, rather than too high,” Kamil Kovar, a senior economist at Moody’s Analytics, said.
“And if the recent trends in inflation and growth continue then 2024 will be the year when the ECB implements a pirouette in monetary policy.”
The ECB argues that underlying dynamics are more stubborn than they appear and inflation will actually come back above 3 per centnext year, only hitting the 2 per cent target in late 2025, partly due to rapid nominal wage growth.
This will require the bank to hold its deposit rate at a record-high 4 per cent for an extended period, and even Yannis Stournaras, the dovish chief of the Greek central bank, sees no cut before mid-2024.
Fresh data on Thursday showing unemployment holding at a record-low 6.5 per cent despite an economic contraction would appear to support this argument as it underlines just how tight the euro zone’s labour market is.
Bank of Italy Governor Fabio Panetta did not explicitly push back on the ECB’s guidance on Thursday but warned about the dangers of keeping interest rates high for too long.
“The duration of this phase will depend on development in macroeconomic variables; it could be short if continued weakness in economic activity accelerates the decline in inflation,” Panetta, a former ECB board member, said. “”We need to avoid unnecessary damage to economic activity.”
Investors are increasingly ignoring ECB President Christine Lagarde’s explicit guidance for steady rates for several quarters, pricing in a combined 115 basis points of cuts for the next year, with a first move by April fully priced in.
A key reason for the discrepancy is that the ECB’s own projections have a poor track record. It has been forced several times in recent years to abandon its guidance after first pushing back on market expectations.
Economists say that growth is weaker than the ECB expected, the labour market is softening and credit demand has evaporated, all pointing to rapid disinflation.
“Also, there is still a lot more of the impact of tightening to come as interest payments are still increasing,” ING economist Bert Colijn said. “The market is therefore right to start looking at rate cuts for 2024. We think the first one could well happen before the summer.”
Some economists argue that modelling current inflation is exceptionally difficult because corporate profits are the main driver, not wages as in normal bouts of rapid inflation.