Markets look to flash inflation figures for the euro area that are due by Eurostat at 11am Central European Time on Friday, January 5. Investors are looking for confirmation of last year's slowdown in consumer prices.
The euro area's annual inflation rate was 2.4% in November 2023, down from 2.9% in October. A year ago, the rate was 11.1%.
In November, the greatest contributors to euro area inflation were services (+1.69 percentage points, pp), followed by food, alcohol & tobacco (+1.37 pp), non-energy industrial goods (+0.75 pp) and energy (-1.41 pp).
Stagnation Is a Greater Risk than Persistent Inflation
According to Tomasz Wieladek, chief European economist at T. Rowe Price, “in the absence of further commodity shocks than currently expected, inflation could fall more rapidly toward the ECB's 2 percent target.”
Wieladek warns against the risk of a return to pre-pandemic era stagnation. “This is a greater risk than persistent inflation,” he said. “If the ECB tightens too quickly, it could plunge inflation back below 2 percent, pushing the Eurozone, once again, into stagnation.”
Eurozone inflation peaked in October 2022 at 10.6% before declining to 2.4% in the most recent read last November. Core inflation, the rate excluding food and energy prices, remains higher at 3.6%, but the disinflation process appears to be well underway.
“Looking, then, at commodity prices, which have been stable for several months, and economic activity, which has normalized after the post-Covid excesses, there is no reason to think that the disinflation process will be interrupted in the months ahead”, said Andrea Conti, Chief of macro research at Eurizon.
Scenarios for an Interest Rate Cut
Entering 2024, inflation data remain a key factor for monetary policy, but the ECB will also take the economic cycle into account.
In the third quarter of 2023, seasonally adjusted GDP decreased by 0.1% in the euro area compared with the previous quarter, according to an estimate published by Eurostat. In the second quarter of 2023, GDP had increased by 0.1%.
“There are two scenarios under which the ECB is likely to initiate a round of rate cuts: first, if growth is weaker than expected; second, if inflation falls toward the 2 percent target faster than expected,” according to Wieladek.
Will Market Euphoria Last?
Financial markets have already moved ahead and priced in a round of rate cuts, but this scenario will have to be confirmed by data in the coming months.
“Fundamentally what drove the market rally in December was the belief that central banks are ready to cut interest rates and that the macroeconomic environment will be more supportive for equity markets in 2024”, said Michael Field, European Equity Strategist at Morningstar. This situation has not changed, and ultimately the inflation, jobs data etc released in the meantime has been supportive of this. So, from that perspective the momentum behind the rally is still there, which means it could continue. The only downer on the party is valuation. European markets have just recently moved from behind slightly undervalued to being slightly overvalued.”
Antonio Cavarero, head of investments at Generali Insurance Asset Management, also sees room for enthusiasm from the end of last year to last into the beginning of 2024, though “it will be important that data in the coming months can confirm what the markets have already priced in. Indeed, there is a possibility that the effects of tightening monetary policies, the relative difficulty of some large economies such as Germany and China may prompt more conservative assessment of riskier investments.”
