FRANKFURT – Euro zone inflation surged last month and could still go higher in the early part of 2024, easing financial markets pressure on the European Central Bank to start cutting interest rates from record highs.
Inflation across the 20-nation bloc jumped to 2.9% in December from 2.4% in November, just shy of expectations for a 3.0% reading, mostly on technical factors, such as the end of some government subsidies and low energy prices getting knocked out of base figures.
The data appear to confirm the ECB’s prediction that inflation bottomed out in November and will now flatline in the 2.5% to 3% range through 2024, well above the bank’s 2% target, before slowing again in 2025 according to Reuters.
In a hopeful sign, however, underlying inflation — defined as price growth excluding food and energy — eased to 3.4% from 3.6%, suggesting that price pressures are still cooling, even as the headline number jumped.
Still, policymakers may be concerned that services inflation jumped 0.7% on the month and the annual reading held steady at 4.0%, as this is closely tied to wages and may be pointing to a quick rise in incomes, which could then fuel price pressures.
The inflation jump comes as investors and policymakers appear to be drawing vastly different conclusions about price trends and their implication for interest rates.
Investors are betting that the ECB will cut rates six times this year with the first move coming in March or April, as an economic contraction and benign wage growth ease inflation, letting the bank unwind its fastest policy tightening cycle on record.
But policymakers argue that price pressures remain abundant and crucial wage settlements are not finished until the first quarter of this year, so it might take until mid-2024 to gain the confidence that inflation is indeed under control.
In fact, some even argue that market rates have eased so much that investors have undone some of the ECB’s work, forcing the bank to keep rates high even longer to get the sort of economic restriction that cools price pressures.
A key source of the divergence in views is that the ECB’s own inflation projections have been off for years, suggesting that the bank does not have a full understanding for price-setting behaviour in exceptional circumstances.
First it predicted just a transitory rise in prices, then a shallower peak, and finally a much slower reversal, fuelling some policymakers to raise their focus on fact figures and lower the emphasis on projections.
