Frankfurt, January 5 – The financial markets’ pressure on the European Central Bank to begin reducing interest rates from record highs has lessened as a result of the euro zone’s inflation increase last month, which is expected to continue in the early months of 2024.
The 20-nation bloc saw a spike in inflation from 2.4% in November to 2.9% in December, barely missing predictions for a 3.0% reading due primarily to technical reasons including the removal of some government subsidies and low energy prices from base data.
The figures seem to support the ECB’s forecast that inflation peaked in November and is now expected to plateau between 2.5% and 3% until 2024—well over the bank’s 2% target—before dropping down once again in 2025.
Though the headline number increased, underlying inflation, which is defined as price growth excluding food and energy, decreased to 3.4% from 3.6% in a positive indication that pricing pressures are gradually easing.
Nonetheless, given that services inflation is strongly correlated with wages and may indicate a rapid rise in salaries, which could subsequently exacerbate pricing pressures, policymakers may be concerned that it increased by 0.7% in the month while the annual reading remained stable at 4.0%.
The spike in inflation occurs at a time when policymakers and investors seem to be coming to somewhat divergent conclusions about pricing patterns and how they affect interest rates.
However, officials contend that pricing pressures are still strong and that significant pay settlements won’t be completed until the first quarter of this year, suggesting that it may take until mid-2024 to feel certain that inflation is in fact under control.
Some even contend that investors have undone some of the ECB’s work because market rates have loosened so much, requiring the bank to maintain high rates much longer in order to obtain the kind of economic restraint that reduces price pressures.
The ECB’s own inflation estimates have been off for years, indicating that the bank does not fully grasp price-setting behavior in unusual circumstances, which is one of the main causes of the discrepancy in views.
It first forecast only a brief increase in prices, followed by a deeper peak and a far slower decline. This led some policymakers to place more weight on actual data and less on projections.
Investors contend that the European Central Bank (ECB) is overly sanguine about growth, and they also cite the strong decline in producer prices (which fell 8.8% in November) as proof that pricing pressures are abating.
Lastly, investors believe that the European Central Bank (ECB) will want to move in lockstep with the world’s largest central bank once it makes a move, perhaps in March or May, given that markets are also banking on the US Federal Reserve to cut rates aggressively.