OpinionMonetary policy

Deceptive success with euro inflation

The ECB's aim of achieving a 2% inflation rate appears close. But the last mile in the fight against inflation will be a long one.

Deceptive success with euro inflation

The European Central Bank (ECB) hasn't been this close to its inflation target of 2% for almost two and a half years. However, what seems within reach is, in reality, still a good distance away. Due to base effects, inflation might rise above the 3% mark again in December, and the final stretch of inflation control will take time.

Base effects are also responsible for the significant drop in the inflation rate so far. Compared to 2022, when the Russian war on Ukraine triggered a major energy crisis, gas and oil prices are significantly lower this year. The downward trend in inflation has been propelled by this factor. Nevertheless, this won't have any significance in 2024.

High core rate

The core rate, which excludes energy prices, illustrates that the price pressure is still significantly higher than the ECB would prefer. The core inflation remains at 3.6%, well above levels compatible with price stability.

How quickly the ECB will achieve its inflation target depends on several factors. These include next year's wage developments, consumer inflation expectations, and the forecasts of financial market participants regarding future monetary policy. All three speak against further rapid success in the fight against inflation.

Although the previously feared wage-price spiral is not likely to occur, wages will rise significantly in 2024, becoming a new driver of inflation. This is no surprise as workers have much ground to make up given the long phase of real wage losses.

Interest rate hike off the table

Consumer inflation expectations have been rising for months, despite all the successes in inflation control. This is bad news for the ECB. When consumers spend in anticipation of a substantial price increase, it adds to the pressure on prices. Furthermore, many financial market participants forecast that interest rates will already decrease in spring, which weakens the restrictive effect of monetary policy as well.

The victory over inflation is far from achieved. Another interest rate hike by the ECB in the current cycle is now definitively off the table based on the November data – provided there is no new exogenous price shock. The timing of the first interest rate cut is expected to be the next contentious issue within the ECB Council. Initially, this debate will likely unfold behind closed doors.