Inflation falls faster than expected
Inflation is falling faster than expected in developed economies, marking a new turning point in central banks' fight against inflation.
Consumer price growth in the UK, US and Europe has cooled, raising expectations that central banks could apply the brakes and start cutting interest rates next year.
Experts say this is a welcome sign in the context of a slowing global economy, raising the prospect of a "soft landing" after a cycle of continuous interest rate hikes in recent times. Not only that, the European economy is also on the brink of recession.
US and European government bonds also showed signs of cooling as investors believe interest rates will soon fall in the near future.
“This is clearly a turning point for inflation,” Stefan Gerlach, former deputy governor of the Central Bank of Ireland, told the Wall Street Journal . “Investors may be surprised by how quickly central banks will cut interest rates next year, potentially by 1.5 percentage points.”
Consumer price growth in the UK, US and Europe has cooled, raising expectations that central banks could "slam the brakes" and start cutting interest rates next year (Photo: Shutter Stock).
The sharp drop in inflation globally also highlights the factors that have pushed prices up, especially in the wake of the Covid-19 pandemic and the Russia-Ukraine conflict.
These factors disrupted global supply chains, reduced the workforce and increased energy prices, especially in Europe. These inflationary pressures have now waned.
Inflation is also driven by supply-side factors, such as the US government's trillion-dollar stimulus package, and pent-up demand and consumer savings during the pandemic.
According to economists, this is the reason why core inflation remains high nearly four years after the pandemic broke out and interest rate hikes are needed to curb inflation.
"We are gradually getting out of the inflation crisis"
Even countries where inflation is considered the most persistent, such as Britain, are starting to see some improvement. However, the Bank of England (BoE) said it was too early to think about cutting interest rates.
Eurozone-wide inflation fell to 2.4% in November, close to the European Central Bank's (ECB) 2% target, with many member states reporting below-target inflation or even deflation.
Cooling consumer prices have convinced some European policymakers that the fight against inflation is being won, and that it will not be as protracted as it was in the 1970s.
"We are gradually coming out of this inflationary crisis," French Finance Minister Bruno Le Maire said at a meeting of European ministers last week. "In less than two years, Europe has managed to contain inflation."
Investors are also more optimistic, believing that the US Federal Reserve (Fed) and the ECB will start cutting interest rates from next year.
Even countries where inflation is considered the most persistent, such as the UK, are starting to see changes (Photo: MH).
The BoE could also cut rates by the end of next year, according to data firm Refinitiv. Market participants see a 30% chance of another Fed rate hike. Notably, the prospect of a rate cut by the middle of next year has risen from 23% to 86%.
Meanwhile, central banks have been more cautious, after being surprised by the persistence of inflation last year. The BoE said last month that it was too early to consider cutting interest rates, forecasting that inflation would reach its 2% target by the end of 2025.
Furthermore, energy prices could rise further if the Israel-Hamas conflict spreads to other parts of the Middle East. Central banks also believe this could have a major impact on inflation.
Morgan Stanley economists predict the BoE will cut rates in May next year, followed by the Fed and ECB the month after that. While the timing varies, there is a consensus that inflation is weakening and lower interest rates are on the way.
“We forecast that inflation and interest rates across advanced economies will decline in 2024,” Michael Saunders, a former official at the BoE, stressed in the report.
"The final leg" of the interest rate hike race
In the event of a rate cut, one question will be whether banks have raised rates too aggressively, especially in Europe.
Economists say previous rate hikes are starting to bite into the economy, reducing credit and spending. Job creation has fallen sharply and unemployment is rising in both the US and Europe, slowing wage growth.
Not only that, according to many economists, households will be more reluctant to spend, because high interest rates make them want to save more. Sharing with the Wall Street Journal, Printemps supermarket in Paris, France is ready for the holidays but is still considering the amount of goods to import because consumers are not ready to spend a lot of money at the end of the year.
With inflation still complicated, domestic economic conditions may become the most important factor as central banks enter the "final leg" to bring inflation down to the 2% target.
In the US, inflation has cooled as the labor market and consumer spending have cooled, but it remains stable. This has led markets to believe that price pressures will continue to fall without triggering a recession.
Amid cooling inflation, officials of the US Federal Open Market Committee (FOMC) unanimously agreed to keep the interest rate unchanged in the range of 5.25-5.5%. FOMC members forecast four more rate cuts in 2025 and three more in 2026, bringing the interest rate to the range of 2-2.25%.
Michael Gapen, a US economist at the BoE, acknowledged that if inflation picks up again, the Fed may have to raise rates further. However, he said the economy is likely to cool and the focus will shift to rate cuts in 2024.
According to economists, households will be more reluctant to spend, as high interest rates make them want to save more (Photo: Financial Times).
"Interest rate forecasts are important because much of the recent rally in stocks has been driven by expectations of lower rates soon," Quincy Krosby, chief global strategist at brokerage LPL Financial, told CNBC . "If they signal yes, the market will continue to rally."
In Europe, the economic situation is more challenging, with the region facing a number of growth challenges, including a slowdown in global trade, reduced government spending and sluggish growth in its key export market, China.
European households are also more reluctant to spend the money they have saved during the pandemic. All of these factors have led to a deeper economic contraction and lower inflation in Europe, prompting the ECB to cut interest rates sooner.
Despite the possibility of lower interest rates in the future, many economists and investors say a return to the pre-pandemic era of ultra-low interest rates is unlikely, given geopolitical tensions.
The workforce is likely to shrink in major economies, including China, in the coming years as millions of its citizens retire. Tensions between China and the West are likely to raise manufacturing costs as companies shift factories to other countries.
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