Metaphorical champagne corks appeared on the market’s trading floors, as a “rapid estimate” of euro zone inflation for November was published at the end of that month.
The annual rate of consumer price increases – at 2.4% – is back within striking distance of the European Central Bank’s 2% inflation target, after falling sharply during the month.
The situation was reversed in the United States, where inflation fell to 2.6%. It peaked at more than 9%.
US Federal Reserve Chairman Jerome Powell issued the usual warnings at the bank’s December meeting, but gave very strong indications that US interest rates will start to fall in 2024.
There was a ‘get the job done’ element about this from the markets.
Stocks rose with some indexes reaching all-time highs. It has been “game on” to cut interest rates with strong expectations that the European Central Bank will be the first major central bank to cut interest rates in March.
Not so fast….
The European Central Bank did not play ball, with its President Christine Lagarde saying at the bank’s December meeting that the Governing Council had not even discussed the possibility of lowering interest rates.
It stuck firmly to the mantra that borrowing costs will remain “higher for longer”, despite lower inflation expectations.
Board member Robert Holzman stressed this warning, saying that a move towards lower interest rates in 2024 is not at all guaranteed.
ECB chief economist Philip Lane – a former governor of the Central Bank of Ireland – said it was too early to talk about the possibility of lowering interest rates, adding that it was too early to declare victory over inflation.
Speaking at an ESRI event just before Christmas, he warned that inflation does not move in a straight line and suggested that the rate could rise temporarily in December.
December surprise
As the new year approaches, there has been a distinct discussion by analysts and economists about the possibility of the European Central Bank cutting interest rates in March.
The focus appears to have shifted to April or June, with some pushing the prospect of a first rate cut to September.
Bets against a rate cut intensified in March, as December inflation figures, published yesterday, confirmed that inflation had indeed jumped in December and returned to nearly 3%.
Some of them have been explained by so-called “fundamental effects” and “technical factors,” such as the end of government subsidies in some larger economies.
However, this appears to have brought the rate cutting party to a grinding halt.
Global stocks snapped a nine-week winning streak, and there was a sell-off in government bonds as yields rose again.
Analysts at Citi wrote in a research note that expectations of early interest rate cuts were overblown.
“The rise was led by the Fed, and the ECB’s December meeting is on track for a cut in mid-2024 at the earliest,” they said.
“Inflation is far from defeated,” noted Christoph Weil, an economist at Commerzbank.
“The ECB is likely to cut key interest rates much less than the market currently expects,” he concluded.
A risky global picture
Future interest rate movements in Europe will be largely dictated by global events and wage movements.
Although inflation has fallen significantly, many workers claim they are playing catch-up, as price increases have so far outpaced wage increases.
In a very tight job market, some employees get what they want and get amazing pay increases. This, in turn, can drive inflation through the classic “wage-price spiral.”
There is also the potential impact of two major international conflicts on Europe’s doorstep.
Although the outbreak of war in Ukraine sent oil prices soaring – sending inflation rates to a double-digit level – the conflict in the Middle East has so far failed to have any meaningful impact on oil prices.
The decision by some shipping companies to redirect fleets around the southern tip of Africa to avoid Houthi rebel attacks in the Red Sea could impact supply chains, potentially causing inflation to rise again, as well as oil prices.
The growth dilemma
Part of the reason oil prices have failed to gain traction is that traders believe growth is slowing globally and demand for the commodity will be much lower than previously thought.
Here the possibility of resuming the interest rate cutting party appears.
Many major economies are performing poorly, including China, where growth has failed to take off to the extent that was expected after Covid restrictions were lifted.
Germany, the largest economy in Europe, is also suffering and has recently taken on the nickname “the sick man of Europe.”
This could force the ECB to take early action, notes Paul Somerville of Somerville Advisory Markets.
He said that markets simply do not believe central banks’ slogan that they will not cut interest rates this year.
“Markets set interest rates. Central banks don’t do that,” he said.
He pointed out that “they believe that the global economy is slowing down. China is slowing down, and the European economy is slowing down.”
“We are in a situation where all interest rates will be cut aggressively.”
What does it mean for mortgages?
Tracker mortgage holders will be pinning their hopes on a rate cut in March.
Having borne the brunt of the ten consecutive increases conducted by the European Central Bank between July 2022 and last September, they, in turn, will automatically receive the immediate benefit from any reduction in interest rates.
Likewise, some of the 70,000 mortgage holders who are due to ditch fixed rates next year will feel comfortable with the prospect of lower interest rates.
Even discounting a full percentage of the initial borrowing rate, they are likely to be looking at much higher monthly repayments.
However, it should be noted that even if interest rates fall, there is no guarantee that banks will fully pass on the reductions to non-tracking mortgage products.
“The major Irish banks have agreed to less than half of the ECB’s interest rate hikes,” says Darragh Cassidy, head of communications at bonkers.ie, although he admits interest rates were already high here to begin with.
“This means that we are unlikely to see major banks respond to interest rate cuts by the ECB immediately. In fact, some major lenders may raise some variable and fixed interest rates again in the new year.
“If the ECB cuts interest rates by just 0.25 or 0.5 percentage points next year, banks may not cut rates at all. At least at first,” he warns.
Talk of 2024 being the year of lower borrowing costs may have been greatly exaggerated.