Eurozone Inflation, A Downward Trajectory

By Brett Hurll   

In a turn of events that may alter the monetary policy landscape, the Eurozone witnessed a significant decline in inflation to 2.9% in October, marking the lowest rate recorded in over two years. This substantial dip from 4.3% in September has bolstered the prevalent anticipation that the European Central Bank (ECB) might refrain from tightening the interest rates further. The marked slowdown in the annual growth of consumer prices is the most modest since July 2021, bringing forth a fresh perspective on the region’s economic dynamics.

This downturn unfolds as the Eurozone’s economy exhibits a contraction in the third quarter, a scenario chiefly attributed to diminishing energy prices alongside a reduction in food inflation, as per the data released by Eurostat, the statistical office of the European Union. The inflation rate of 2.9% in October not only falls short of the economic forecast of 3.1% but also signals a paradigm shift among the world’s prominent central banks. It appears that these institutions deem their efforts to curb inflation down to the 2% target as largely accomplished.

Carsten Brzeski, the Global Head of Macro Research at ING, articulates this scenario as a pivotal juncture where major central banks acknowledge the initial triumph over inflation. They are seemingly transitioning into a phase of maintaining elevated rates for an extended period, the duration of which remains uncertain.

The ECB, aligning with this trend, retained its benchmark deposit rate at 4% last week, halting an unprecedented streak of ten consecutive augmentations. This stance is mirrored by the US Federal Reserve, which is anticipated to maintain the interest rates during its upcoming meeting on Wednesday. Similarly, the Bank of England is projected to follow suit the subsequent day, especially in light of the recent data that revealed a decline in UK shop inflation to its lowest in over a year, primarily due to reduced food prices.

However, the trajectory of inflation might experience a deceleration in its decline, with the ongoing Israel-Hamas conflict escalating energy prices. Moreover, the diminishing base effect, when comparing energy prices to last year’s elevated levels, could potentially influence this trend.

As Jack Allen-Reynolds, an economist at Capital Economics, predicts, the pace at which inflation has been falling is unlikely to sustain. He foresees a modest resurgence in energy inflation in the forthcoming months.

The inflation dynamics across the Eurozone present a broad spectrum, showcasing a stark contrast from 7.8% in Slovakia to a deflation of 1.7% in Belgium for the year leading to October. This drastic deceleration in prices mirrors a subdued activity within the region’s economy on a broader scale. Eurostat unveiled that the economy contracted by 0.1% in the three months leading to September, a figure that underwhelmed the economic predictions. This contraction was driven by economic shrinkage in Germany, Ireland, and Austria, despite the growth observed in Spain and France.

The Eurozone's economic narrative over the past year has been one of scant growth, as rising borrowing costs, a weaker global trade environment, and a significant uptick in living expenses besieged both consumers and enterprises. Germany’s economic performance, as confirmed on Monday, remained particularly lackluster, with its Gross Domestic Product (GDP) contracting by 0.1%.

Contrastingly, the US economy has exhibited a robust expansion, boasting an annualized growth of 4.9% in the third quarter as reported last week. Rory Fennessy, an economist at Oxford Economics, opines that the Eurozone is bracing for a phase of economic stagnation. The pathway towards growth could only be envisioned once there's a significant positive turnaround in real income growth. The momentum as we venture into the fourth quarter remains notably weak, burdened by stringent financial conditions.

On Tuesday, data revealed that the core Eurozone inflation, which omits energy and food costs, aligned with predictions, descending to 4.2% from 4.5% in September. This metric is crucial for the ECB, serving as a barometer for underlying price pressures. Christine Lagarde, the President of the ECB, emphasized last week that wage growth is a critical determinant for projecting the inflation outlook. She also mentioned that insights on subsequent collective wage bargaining agreements with unions might only materialize well into 2024, hinting at a prolonged wait before the bank could contemplate reducing borrowing costs.

Mark Wall, the Chief European Economist at Deutsche Bank, echoes a similar sentiment, suggesting that a clear slowdown in wage inflation could necessitate a longer duration, possibly extending for another six months. This nuanced analysis sheds light on the complex interplay between inflation rates and monetary policies, underscoring the imperative for a well-calibrated approach to navigate the economic uncertainties looming over the Eurozone.