Eurozone inflation pressures still simmering

Inflation warning

Early this year, as our Eurozone Future Inflation Gauge (EZFIG) began a cyclical upswing, we noted that “an upturn in actual Eurozone inflation is now on the horizon.” Awkwardly for the European Central Bank (ECB), the inflation upswing — particularly in core inflation — has already begun.

An awkward affair

Our process formally identified a cyclical upturn in the forward-looking Eurozone Future Inflation Gauge (EZFIG). As expected, coincident CPI inflation increased, led by a resurgence in core services growth, followed by an uptick in core goods growth.

Today, the EZFIG remains in a cyclical upswing, driven in part by our Italian Future Inflation Gauge, which continues to strengthen.

Serial surprises

In January, based on ECRI’s forward-looking inflation indicators, we warned in The Column that “international inflation may start firming by mid-2024, challenging assumptions about central banks' rate-cut plans.”

By spring, the ECB was ready to start cutting rates. However, just days before its clearly-signaled first rate cut, Eurozone CPI data surprised to the upside.

The preliminary year-over-year (yoy) core CPI growth for May came in at an unexpected 2.9%, well above consensus expectations of 2.7%, with headline CPI growth also surprising to the upside. This hot data prompted the ECB to implement a so-called “hawkish cut,” which included cautionary language.

For the next two months, yoy core CPI growth continued to surprise, remaining at 2.9% before slightly easing to 2.8% in August and 2.7% in September. Last month, despite sticky core CPI data, the ECB pushed through its second rate cut, supported by a decline in headline CPI growth, aided by lower energy prices.

Challenges ahead

Nevertheless, eager to declare victory, the ECB plans to proceed with further rate cuts, even though core inflation remains stubbornly above target. Recent weak Eurozone economic growth data may provide some justification for these cuts.

However, the challenge is that slower economic growth doesn’t necessarily result in lower inflation. This raises the question of whether the ECB, in its rush to cut rates, risks stagflation, with services inflation remaining elevated, refusing to fall below 4%.

Quo vadis?

To determine where inflation is headed next — and how this will affect the ECB’s ability to continue rate cuts — it’s essential to monitor the forward-looking EZFIG, rather than relying on backward-looking data.

If the EZFIG remains strong, it will signal that elevated inflation will constrain the ECB from cutting rates as quickly as it would like. However, if the EZFIG begins to decline, that would give the green light for more aggressive rate cuts.

For investors, such foresight is invaluable in determining which asset classes to prioritize. Armed with this insight, business decision-makers can better anticipate the interest rate environment and plan accordingly.

We’ll continue to closely monitor our forward-looking indicators. As Wayne Gretzky famously said, “Skate to where the puck is going, not where it’s been.”