Euro zone inflation falls to two-year low of 2.4%, bringing rate cuts into focus

Euro zone inflation fell by more than expected in November, tumbling to a two-year low of 2.4 per cent, down from 2.9 per cent in October.

The faster-than-anticipated decline is likely to fuel speculation that the European Central Bank may start bringing down interest rates earlier, possibly in early spring in defiance of the bank’s guidance and expectations that Franfurt would not start cutting rates until at least the Summer of 2024.

Price growth across the single currency bloc dropped to 2.4 per cent in November, below expectations for 2.7 per cent, with inflation across of all items – except unprocessed food – falling.

The main anchor was energy. On an annual basis, energy prices were down 11.5 per cent in November.

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Even underlying price pressures eased more quickly than forecast, with inflation excluding food and energy, a measure that is closely watched by ECB policymakers, declining to 3.6 per cent from 4.2 per cent on the back of falling service prices.

The latest inflation figures for the Republic, published on Wednesday, show headline price growth here fell to 2.3 per cent, its lowest level in 2½ years and close to the ECB’s target rate of 2 per cent.

The ECB argues that underlying dynamics are more stubborn than they appear and inflation will actually come back above 3 per cent next year, only hitting the central bank’s 2 per cent target in late 2025, partly due to rapid nominal wage growth.

Fresh data out on Thursday showing unemployment holding at a record low of 6.5 per cent, despite an economic contraction, would appear to support this argument by underlining just how tight the euro zone’s labour market is.

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 own 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.

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.

“Because profit-led inflation is a relatively rare event, focused on the end of supply chains and dependent upon narrative economics, mathematical models are not terribly good at forecasting it,” Paul Donovan at UBS Global Wealth Management said.

“This means that not only does inflation slow, but the pace of the slowdown tends to surprise consensus forecasts.” – Additional reporting: Reuters