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The flash estimate of euro area inflation for November confirmed the disinflationary signals from the national data released over the past day: the pace of disinflation has accelerated to such a degree that it is reflective of an ongoing euro area recession and an ECB that now looks to have overtightened policy.
The flash headline inflation rate fell 0.5pp from October to undershoot consensus expectations by 0.3pp with a reading of 2.4% YoY in November. Driving the substantial decline in the headline rate was energy, which was a larger drag at -11.5% YoY compared with -11.2% in October. That is unlikely to provide the ECB with much comfort, however, as the acceleration in the pace of disinflation was visible across all aggregates. Services inflation fell from 4.6% to 4.0% and non-energy goods inflation was down from 3.5% to 2.9%, leaving the core measure to fall 0.6pp to 3.6%. Furthermore, the underlying pace of price growth also dropped off considerably. Core inflation fell -0.6% MoM in November from +0.2% the month prior, with the bulk of that occurring in cyclically sensitive services, which saw prices fall by -0.9% on the month. While Eurostat doesn’t provide a comprehensive breakdown until the final inflation figures are released, it wouldn’t be a surprise if the bulk of the easing inflation pressures stemmed from weakness in consumer discretionary services and labour-intensive components, as recent data has shown slack re-emerging in the labour market and weakness in consumer demand conditions.
However, we do note that some level of caution must be applied when extrapolating a signal from November’s monthly services figure as seasonal discounting likely also played a role.
Nevertheless, if today’s flash numbers are confirmed in the final reading, this leaves eurozone inflation tracking at 2.65% in the fourth quarter, considerably below the 3.3% average estimate in the ECB’s September projections.
While there are grounds to believe that eurozone HICP will pull back in December, such as base effects and a likely rebound in services inflation once seasonal discounting is removed, it is improbable that average headline inflation will rise back above 3% in the fourth quarter – a level the ECB previously didn’t expect inflation to fall below until this time next year. Coupled with the fact that the ECB’s new staff projections will now need to be conditioned on energy prices that are circa 10% lower than in September, the slower pace of inflation should lead to a considerable downgrade in December’s inflation forecasts. This should formally open the debate over the timing of the ECB’s first rate cut. President Lagarde has already shown some tacit acknowledgement of this eventuality, as she stated earlier this week that the discussion on ending PEPP reinvestments earlier than the previous guidance will soon be had by the Governing Council. This is crucial as a formally announced plan to end PEPP reinvestments is viewed by most economists as a prelude to rate cuts in the ECB’s sequencing.
For markets, data released since Thursday morning have provided a dose of macro reality. Not only has the progress on disinflation accelerated at a concerning pace, but activity data out of France has confirmed PMI readings that suggested the second largest euro area economy entered contraction in Q3 and likely remains in that state, while data out of Germany showed the unemployment rate ticking up further, and Chinese PMI data suggested the eurozone can’t even rely on external growth conditions for support. All told, the latest suite of macro variables tells a consistent story that monetary policy in the eurozone is too tight and has induced a recession. This validates our long-held view that the ECB should begin to ease policy as soon as April 2024, with risks that a more sinister downturn in growth could warrant a rate cut as soon as March.
Markets are now aligned with our base case, with a rate cut fully priced in for April and a 50% probability of a cut in March now factored into EUR swaps this morning.
Markets now price a full rate cut from the ECB by April
Author:
Simon Harvey, Head of FX Analysis