Inflation in the euro area has taken a significant dip, reaching its lowest level in over two years. Euronews Business breaks down the latest figures.
ADVERTISEMENTThe latest data from Eurostat reveals that the inflation rate in the euro area, or eurozone, declined to 2.4% year-on-year (y/y) in November 2023, down from a 2.9% annual rate in October 2023.
This slowdown in inflation brings the European Central Bank (ECB)'s 2% inflation target back into clear focus for the first time since the summer of 2021, potentially signaling an imminent shift in monetary policy.
The drop in inflation was driven by various factors. Energy costs fell by 11.5%, a more significant decline compared to October's -11.2%. In addition, inflation rates eased for services (4.0% vs. 4.6%), food, alcohol, and tobacco (6.9% vs. 7.4%), as well as non-energy industrial goods (2.9% vs. 3.5%).
Even after excluding the volatile energy and food items from the inflation calculation, price pressures have fallen to 3.6%, the lowest level since April 2022, and below the earlier forecasts of 3.9%.
Markets now fully price in ECB rate cut in April 2024
The ongoing trend of disinflation in the eurozone has prompted market bets on interest rate cuts by the ECB in 2024, as borrowing cost are currently at historic highs.
Prior to the release of the inflation data, euro area's interest rate futures already incorporated expectations of over 110 basis points of rate cuts in 2024. This effectively implied the possibility of at least four rate cuts of 25 basis points each by December 2024.
While Bank of Greece Governor Yannis Stournaras recently expressed some skepticism about an April rate cut, the weaker-than-expected November inflation report has led traders to fully price in a rate cut for April 2024.
However, the November inflation report has further reinforced market expectations that the ECB will cut rates earlier next year, with traders now fully pricing in a cut in April.
“Risks for euro zone economy are tilted to the downside,” Bank of Italy Governor Fabio Panetta, known for his dovish stance within the ECB board, said after the release of the inflation report.
What could lead the ECB to cut rates in 2024?
The European Central Bank kept interest rates unchanged during its latest meeting in October, ending a 15-month streak of consecutive rate hikes.
However, as the disinflationary trend coincides with a slowdown in economic activity, pressure is mounting on the ECB to consider a rate cut in the first quarter of 2024.
The real interest rate in the eurozone, calculated as the difference between ECB policy rates and inflation, has now reached 2.1%, the highest level since July 2007. This situation effectively translates into an excessively restrictive monetary policy given the current economic state of the euro area.
In addition to rising real interest rates, the euro area's GDP contracted by 0.1% in the third quarter of 2023, and signs of economic strain persist, potentially leading to a technical recession in the fourth quarter.
Private sector activity surveys, as gauged by the Purchasing Managers' Index (PMI), indicate contraction in both manufacturing and services sectors, with readings falling below the 50 thresholds in November.
“The Eurozone economy is stuck in the mud. Over the last four to five months, the manufacturing and services sectors have both been experiencing a relatively constant contraction pace. Considering the flash PMI numbers for November in our nowcast model indicates the potential for a second consecutive quarter of shrinking GDP. This would align with the commonly accepted criterion for a technical recession,” Dr. Cyrus de la Rubia, Chief Economist at Hamburg Commercial Bank, said.
What could prevent the ECB from cutting rates in 2024?
Despite the prevailing economic challenges, a resurgence in inflation could keep the ECB more hawkish than anticipated. Given the current economic contraction in the euro area, any resurgence in inflationary pressures would need to originate from external factors.
One wildcard in this context could be energy prices and their ability to transmit inflationary pressures to other consumer items. For instance, larger oil production cuts by OPEC+ could be a development closely monitored by policymakers in Frankfurt. However, dovish members of the ECB may prefer to focus on core price pressures, leaving energy outside of the equation.
As the euro area navigates through these economic uncertainties, the question remains: when will the ECB decide to cut interest rates in 2024? The answer will likely depend on the evolving economic and inflationary landscape in the coming months.
