WILL THE EUROPEAN CENTRAL BANK BE THE FIRST TO CUT INTEREST RATES?

13.12.2023 Eurozone inflation has fallen rapidly in recent months. Below we look at the prospects for an early rate cut.

Eurozone inflation, over the last few months, has fallen back sharply from an annual rate of 5.2% in August to 2.4% in November. Furthermore, core inflation (inflation excluding food and energy) has fallen from 5.5% to 3.6% over the same period. This confirms that underlying inflationary pressures are falling as well as the headline measure.

With headline inflation now within touching distance of the European Central Bank’s target of 2 percent this will give it the opportunity of reconsidering its monetary policy stance in the New Year.

At present the Eurozone economy is in a state of modest contraction (recession). This will have the effect of exerting further downward pressure on inflation in the coming months.

The other key consideration for policy makers is the tightness of the European labour market. The unemployment rate hit a record low of 6.4% over the Summer, but has now started to rise. Wages, depending on the exact measure used, are currently growing at a rate of between 4 and 5 percent per annum. This is not consistent with the 2 percent inflation target.

So European monetary policy is set to remain on hold until the results of the Spring 2024 wage round are available. If wage growth moderates to between 3 and 4 percent then this is likely to give the European Central Bank scope to start cutting interest rates in the Summer.

Currently it looks like the European Central Bank will be first major central bank to begin easing monetary policy. The US central bank still has above target inflation and relatively strong growth to contend with. Meanwhile the Bank of England has above target inflation and elevated wage growth to navigate.

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This post was written by Robin