Global inflation has deescalated, has the turning point in monetary policy come?

“This is definitely a turning point for inflation. Investors may be surprised by how quickly central banks will reduce interest rates next year.

Inflation is falling faster than forecast in developed economies, leading to a turning point in central banks’ two-year fight against inflation – according to the Wall Street Journal.

Last October, the growth rate of consumer prices fell below 5% in the UK and below 3% in the US and eurozone. These developments have raised expectations that central banks may end their interest rate hikes and move to rate cuts in 2024. This prospect provides an important relief for The global economy is already struggling (with the exception of the resilient US economy), increasing the possibility of a soft landing – bringing inflation down with successive interest rate hikes without causing the exchange rate to fall. Unemployment rate increased. For Europe, this is especially meaningful because the continent’s economy is close to recession.

Reflecting expectations that interest rates may soon be cut, government bond yields in Europe and the US have dropped sharply recently. For much of this year, economists have wondered whether growth and inflation did not decelerate more sharply under the pressure of high interest rates. It is now increasingly clear that high interest rates have begun to exert their delayed effect on growth and inflation.

INVESTORS ARE OPTIMISTIC, CENTRAL BANK STILL CAUTION

“This is definitely a turning point for inflation. Investors may be surprised by how quickly central banks will reduce interest rates next year. Perhaps the total reduction will be up to 1.5 percentage points,” said Mr. Stefan Gerlach, a former Governor of the Central Bank of Iceland.

The simultaneous decline in inflation across continents shows that the initial cause of high inflation in different countries is the same, especially due to the Covid-19 pandemic and the Russia-Ukraine war. These factors have disrupted supply chains, reduced the number of people in the workforce and pushed up energy prices, especially in Europe. When such causes of inflation weaken, the upward pressure on prices is naturally relieved.

In the past, inflation has also been driven by demand-related factors, such as the US government’s trillions of dollars in stimulus money, as well as pent-up demand and savings accumulated by consumers. during the pandemic. Economic experts say that is why inflation remains high after nearly four years of the pandemic, and why rates need to increase to pull inflation down.

Falling inflation “shows the impact of a 4-5 percentage point increase in interest rates,” Mr. Gerlach said. “Those who think that high inflation will reduce on its own are wrong,” he emphasized, referring to the debate among economists about whether inflation will deescalate on its own or not. Previously, Mr. Gerlach belonged to the camp that said inflation had reduced on its own. “Our idea before was that inflation would decrease on its own without raising interest rates,” he said.

Even countries where inflation is most stubborn, such as the UK, have begun to see positive developments. The consumer price index (CPI) in October increased by 4.6% over the same period last year, down from the 6.7% increase recorded in September and was the lowest increase since October 2021. Before this data was released, economic experts predicted that the UK’s October CPI would increase by 4.8%.

“Now, the UK is no longer an inflation exception,” said Morgan Stanley economist Bruna Skarica.

In the US, October CPI increased by 3.2% over the same period last year, a much lower increase than forecast. Consumer price inflation in the eurozone in October was 2.9%, from 4.3% in September. In Belgium and the Netherlands, inflation also decreased simultaneously.

Weak consumer prices have convinced some European policymakers that they have won the battle against inflation, and won it over a shorter period of time than in the 1970s – when Europe fall into a similar inflationary situation.

“We are in the process of escaping the inflation crisis,” French Finance Minister Bruno Le Maire said recently. “In less than 2 years, Europe will control inflation, a problem that has put pressure on people and households, especially those with poor economic conditions.”

Investors are even more optimistic than monetary policymakers. Data from CME’s FedWatch Tool shows that traders are betting almost 100% that the Fed will not raise interest rates at its December meeting but will instead leave them unchanged at 5. 25-5.5% currently. Bets on the timing of the first interest rate cut in 2024 were also pushed to May, instead of June as before. Before the US October inflation data was released last week, the possibility of the Fed raising interest rates at its December meeting was 30%.

The European Central Bank (ECB) is also forecast to cut interest rates from spring next year, followed by the Bank of England (BOE) in the summer.

For their part, central bankers are taking a cautious stance, as they were caught off guard by the persistence of inflation last year. In October, BOE said it was too early to think about cutting interest rates. BOE currently forecasts that by the end of 2025, inflation will decrease to the target of 2%. Officials also mentioned the still large growth rate of wages and the risk of escalating energy prices if the Israel-Hamas war spreads to the Middle East.

THE DIFFICULT LAST STAGE OF THE WAR AGAINST INFLATION

Economists at investment bank Morgan Stanley forecast the BOE to start cutting interest rates in May, followed by the Fed and ECB in June. But whichever forecast is correct, there is a growing consensus that inflation is receding and will be followed by lower interest rates. “We forecast inflation and interest rates will fall broadly in 2024 in developed economies,” said Michael Saunders – a former OBE official, now working at economic research firm Oxford Economics – identify.

If that’s the case, the question is whether central banks have raised interest rates too much, especially in Europe. Economists say interest rate hikes are already seeping into the economy, putting downward pressure on lending and consumption. Job growth is slowing and unemployment is inching up on both sides of the Atlantic, causing wage growth to weaken. Households are more reluctant to spend because high interest rates provide greater benefits to saving money. All these factors cast a shadow on economic growth prospects in the coming months.

Recent statistics show that US retail sales decreased 0.1% in October compared to September, marking the first monthly decline since March, after increasing 0.9% in September. eurozone, industrial output in September decreased by 1.1% compared to August.

But although global factors are the main cause of inflation rising sharply last year and falling sharply recently, each country’s internal problems may be the most influential factors. as central banks enter the final stages of bringing inflation to the 2% target.

In the US, inflation is weakening thanks to slowing consumer and job growth, but both the job market and American spending are holding firm. This fact leads to forecasts that price increases in the world’s largest economy will continue to decrease but a recession will not occur.

For Europe, the economic environment is much more difficult than in the US. The continent is facing many headwinds to growth, from slowing global trade to the sluggish economy of China – an important export market for European manufacturers – and efforts to by governments to limit public spending. Not to mention, households in Europe are also more cautious than households in the US in spending money saved during the pandemic. All of this may cause the European economy to decelerate faster and inflation in Europe to decrease faster than in the US, leading to the ECB lowering interest rates earlier than the Fed.

Although the prospect of central banks lowering interest rates has become clearer, experts and investors believe that it will be difficult for the world to return to the era of super low interest rates like before the pandemic. The cause here is geopolitical tensions and demographic pressures. The workforce is likely to enter a period of decline in major economies, including China, as baby boomers age. The deterioration of China’s relationship with the West is expected to push up production costs as businesses have to move production out of China.