Central Banks Caution Against Declaring Victory Over Inflation

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Eurozone Market Update

In November, eurozone inflation was 2.4% year-over-year, below expectations of 2.7% and October’s 2.9%. Core inflation, which excludes more volatile food and energy prices, fell to 3.6% from 4.2% in October, thanks to the continuing decline in energy prices. Despite this trend, ECB President Christine Lagarde stated, “It is not time to start declaring victory on inflation.” But markets are still moving forward with their forecast of 113 basis points (bps) in cuts by the end of 2024. Q3 GDP for the eurozone came in at -0.1%, missing market expectations of 0% and reflecting the region’s stagnating economy. Monthly retail sales fell 0.5%, in line with the depressed consumer confidence levels, allowing the market narrative to persist that the ECB is most likely done with hiking rates.

_{Source: Bloomberg, data as of 30 November 2023}

UK Market Update

As expected, the BoE left its monetary policy unchanged for the second successive meeting, with the deposit rate remaining at 5.25%. The only major change came from the BoE’s forward guidance, which indicated that monetary policy will likely be restrictive for an extended time. The bank continues to highlight that further tightening would be required if evidence of more persistent inflationary pressure arises. Governor Andrew Bailey later commented, “We are not in the place to discuss cutting interest rates — it is not happening.” Inflation fell to 4.6% year-over-year from 6.7%, but core inflation remained sticky at 5.7%. November’s flash composite Purchasing Managers’ Index (PMI) beat expectations with a 50.1 reading, bringing the UK back into expansionary territory.

_{Source: Bloomberg, data as of 30 November 2023}

US Market Update

In November, the Federal Open Markets Committee (FOMC) left the federal funds target rate range unchanged at 5.25-5.5%. The only modest change in the accompanying statement noted that growth “expanded at a strong pace in the third quarter,” job gains “moderated since earlier in the year” and “tighter financial and credit conditions” are likely to weigh on the economy. The Fed preferred inflation gauge, the Personal Consumption Expenditure Price Index, softened to 3.0% year-over-year from 3.4%, ensuring rates will remain on hold at the FOMC December meeting. The latest Q3 GDP print exceeded expectations, accelerating to 5.2% from 4.9%, driven by non-residential fixed investments and state and local government spending

_{Source: Bloomberg, data as of 30 November 2023}

Looking Ahead

The three central banks continued their holding pattern in the most recent round of policy meetings. Subsequently, market participants have concluded that central banks have reached the peak of their hiking cycles and have shifted their focus to the timing of the first interest rate cut as well as the magnitude of easing during 2024. While headline inflation has fallen substantially, the reaction function of central bankers will be driven far more by the sticker core component that excludes volatile energy and food data. We would caution against optimism that the inflation battle has been won. While inflation is trending in the right direction, we believe that the path to 3% on core prices is much easier to obtain than getting back to central bank targets of 2%. We believe the market is pricing in a premature start to the cutting cycle and overestimates the magnitude of easing for 2024.

Chart of the Month: Recently Changing Market Expectations for Bank Of England Rate Cuts in 2024

_{Source: Bloomberg as of 30 November 2023}

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