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EU and UK CPI Change Rate Expectations

Stavros Tousios | Wednesday 20 December 2023

Central banks worldwide face pressure to pivot and cut interest rates as inflation slows. The ECB was at the center of that debate on Tuesday, December 19, after eurozone inflation fell as expected to 2.4% in November until the UK published its own data on Wednesday, December 20. 

UK CPI inflation slowed substantially lower than analysts expected. The softer reading caused the pound to weaken against the dollar (GBPUSD), falling 0.6% below $1.27.

While some central banks may want to distance themselves from market movements, they acknowledge the direction of markets and that rate cuts may be needed eventually. However, they remain wary of reacting too quickly and risking a resurgence of inflation and will only cut rates to the extent needed to support the economy.

An image of the UK and Eurozone flags

US and EU Central Banks Diverge on Pivot

Central banks face challenges between signaling a hawkish stance and acknowledging a pivot as inflation slows, but not to the same degree. The Fed's decision to slow down rate hikes and possibly cut rates next year was not met with the same enthusiasm by the ECB or BOE as the European cartel maintained its stance of keeping monetary policy tight. 

ECB President Christine Lagarde said rate cuts had not been discussed and pushed back the idea of an imminent policy pivot. In that same tune, the BOE had said inflation is expected to remain around 4.5% through the end of this year, well above their 2% target. Both made these remarks following their last policy decisions in December. 

The International Monetary Fund (IMF)'s Kristalina Georgieva had also cautioned against premature rate cuts last Friday, December 15, after the Fed signaled interest rate cuts in 2024. She advised central banks not to rush to relax their fight against inflation just because the Fed signaled a pivot. Some ECB officials were attuned to these comments, warning it is “too early” indeed, while others said that rates may need to be cut soon. 

But as the talk continues, officials allow markets to ease credit conditions and balance the narrative as the full impact of past rate hikes takes effect. Some experts argue that central banks are aware of the impact of their comments and are using them as a means to achieve a soft landing. Regardless, markets are still pricing in rate cuts from the ECB and BOE next year despite their reluctance to pivot.

Is Slowing Inflation Changing Dynamics?

The market is pricing in earlier and more aggressive rate cuts than central banks seem ready to deliver in 2024 despite inflation across Europe and the UK falling. Both ECB and BOE meeting statements remained hawkish, focusing on price pressures and signaling that interest rates will remain restrictive for a long period. However, inflation in the UK is falling faster now, following the last CPI print in the UK.

UK inflation slid well below economists' expectations of 4.3%, witnessing a sharp decline to 3.9% in November, its lowest level in over two years. Lower fuel prices were a major driver for the fall, as they dropped 22% year-on-year in November. The disappointing reading has increased the chances of an interest rate cut by the BOE as early as May 2024. While the figure offered some hope the BOE may accelerate its rate cut, food prices remained 9% higher than a year ago, and wage growth poses a concern. 

As far as the Eurozone goes, November’s Inflation rate in the Euro Area decreased to 2.4% from 2.9% in October. Core inflation, which discounts food and energy prices, also eased to 3.6%. 

In fact, energy prices declined by 11.5% in November. However, the ECB now expects inflation to pick up due to base effects and the phasing out of fiscal measures to limit the impact of energy price shock.      

Analysts had expected the ECB to cut rates for the first time in July 2025, earlier than previous forecasts of a September 2025 reduction. Following the CPI report on December 19, money markets now point to a near 50% probability of a March cut.

What Data Keep a Keen Eye on?

After a stretch of interest rate hikes last year and in 2023, major central banks now signal they may reduce interest rates next year. The Fed appears most open to cuts, followed by the ECB and BOE. Based on the central banks' comments, investors are more convinced that the Fed will make rate cuts sooner than the ECB and BOE. In fact, ECB and BOE officials have said they need more evidence that growth is substantially weakening before considering rate cuts.

In that vein, the ECB trimmed its 2023 growth forecast from 0.7% to 0.6% and its 2024 growth forecast from 1% to 0.8% while announcing plans to speed up the shrinking of its balance sheet. Although tighter financing conditions are helping control inflation, growth will be slow in the short term, with PMI and employment data watched closely by the ECB. (Source: CNBC)

Over the UK, the BOE may be awaiting more clarity on wage growth data before making any decision. Officials want to know if still-high wage growth is a “one-off” reaction to inflation or a result of a hotter labour market. However, it lacks reliable data on unemployment and wage growth trends due to issues with survey data. 

Lastly, UK wage growth released on December 12 slowed to 7.3%, the slowest rate in almost two years, suggesting interest rate hikes are starting to take effect, and the BOE won't have to cut rates soon.

Wrap Up

EU and UK inflation appear to have prompted markets to start pricing in sooner rate cuts by both the ECB and BOE. As we move forward, it will be crucial to keep a close eye on future data the central banks deem crucial to make decisions on interstates. Are they going to follow the Fed in its dovish pivot or defend their hawkish stance for longer?

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