Euro zone inflation rises in December and partially cools expectations for rate cuts

Eurozone inflation increased to 2.9% in December from 2.4% in November, just below the expectation of a 3.0% reading. This supports the European Central Bank’s (ECB) decision to keep interest rates at record highs for some time.

The rise in inflation is attributed to technical factors, such as the end of some government subsidies and the impact of low energy prices getting knocked from base figures.

The ECB predicts that inflation bottomed out in November and expects it to hover in the 2.5% to 3% range throughout the year, well above its 2% target. The central bank anticipates inflation to fall back to the target in 2025.

While base and fiscal effects could keep the headline figure elevated, overall pressures may be easing. The focus now turns to how wage settlements and global political tensions will impact prices.

Wage deals are typically finalized in the first quarter in much of the eurozone, but data on their impact won’t be available until May.

Geopolitical tensions, such as disruptions in shipping via the Suez Canal, could affect transportation costs and potentially lead to inflationary pressures.

Investors are betting on a rapid fall in borrowing costs, expecting the ECB to cut rates six times in the year, with the first move in March or April. In contrast, policymakers argue that it might take until mid-2024 to gain confidence that inflation is under control.

Some analysts point out that the ECB’s own inflation projections have been off for years, suggesting a lack of a full understanding of price-setting behavior in exceptional circumstances.

Investors, on the other hand, argue that the ECB is too optimistic on growth and highlight a sharp drop in producer prices (down 8.8% in November) as evidence of cooling price pressures.

In summary, the divergence in views on inflation and interest rates reflects the complexities and uncertainties in the economic landscape.

While inflation has increased, there are concerns about the changing structure of inflation, and investors and policymakers differ in their expectations for future rate moves.

The evolving economic conditions, geopolitical factors, and the impact of various variables on inflation will likely continue to shape the policy outlook in the Eurozone.