Disinflation will force ECB to cut rates earlier than expected

Hi, I’m Angel Talavera, Head of European Economics at Oxford Economics. One of our key macro calls for 2024 is our view that eurozone inflation will be lower than what the market and what the ECB expects. Three main factors drive our call. We expect a stronger disinflation from energy prices as a result of the delayed passthrough of lower wholesale gas and electricity prices to consumers.

We also think food inflation will be lower than what the ECB assumes, given the easing we are seeing in pipeline pressures, although food prices will remain very high. And finally, we also anticipate a stronger slowdown in core inflation, especially for industrial goods, which is consistent with our weaker outlook for growth.

Our below consensus inflation view means that we are also more dovish than the market on the outlook for interest rates. We think the ECB will start cutting rates in the second quarter of 2024 as both headline and core inflation moves close to the ECB’s 2% target. The release this week of the latest inflation figures for October confirmed our view that the disinflation process in the euro area is intensifying. Eurozone inflation fell to the lowest level in two years, and although this was partially driven by volatile energy prices, the release confirmed that core inflation, which is the more relevant metric for policymakers, is trending down as well.

The momentum for core inflation is now substantially weaker than it was a few months ago. This is particularly true in prices for goods, but it’s also happening in services where prices have long been expected to be much stickier. Interestingly, the inflation release has meant a fast repricing of market expectations in recent days, which have moved much closer to our own view. Like us, the market is now also pricing in a first rate cut in Q2, although we still see a faster pace of rate cuts in the second half of 2024, consistent with our view of lower inflation.