Investors May Be Overlooking Recent Inflation Slowdown

As inflation remains a pivotal topic for investors globally, there's growing evidence suggesting that the rapid rise in prices is beginning to ease.

How is coolinginflation affecting interest rates?

In Europe, inflation is typically measured by comparing prices year-over-year, a method that helps avoid seasonal distortions. This approach, however, can be slow to reflect sudden shifts in the underlying inflation rate. In contrast, the United States employs a method where seasonal trends are removed from data, allowing for a more immediate understanding of month-to-month price changes. The European Central Bank does offer seasonally adjusted data, but the predominant focus in Europe remains on year-over-year unadjusted price changes. This perspective suggests that inflation is decreasing but remains high, influencing the belief that interest rates must stay elevated to control inflation.

The Pace Of Disinflation And Market Implications

Looking at seasonally adjusted data reveals a more rapid disinflation rate, presenting a less alarming view of current inflation levels. In the Eurozone, core inflation even showed a negative turn in recent data, indicating a clear trend of easing. A similar pattern is observed in the UK, where monthly price increases have become more manageable, despite high year-over-year inflation figures. This changing landscape is leading investors to grow confident that rate hikes have peaked and rate cuts could be imminent.

UK Inflation Drops to 3.9% in November, Prompting Rate Cut Speculation
A sharp reduction in UK inflation triggers market shifts and discussion on early interest rate cuts by the Bank of England.

The trajectory of wages echoes this disinflation trend. The Bank of England's preferred measure of private sector pay surged in the spring, but the rate of increase has significantly slowed, with wages even falling in the most recent data. This shift strengthens the argument that inflationary pressures are receding. Although caution remains due to past experiences with wage and price acceleration, the likelihood of a significant and sustained uptick now appears lower.

Current high-interest rates are seen as a precaution against potential inflation reacceleration. However, with rates already in a restrictive range, the focus shifts to whether the trend of cooling inflation will persist. There's a growing possibility that inflation might soon fall to uncomfortably low levels, suggesting that the market might be underestimating the extent of future rate cuts.

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