The U.S. Department of Commerce and the European Union's statistical office released data on Nov. 30 showing a significant decline in inflation in both the U.S. and Europe. The U.S. Personal Consumption Expenditures (PCE) price index for October showed a year-over-year increase of 3.0%, while the Eurozone's Harmonized Index of Consumer Prices for November increased by 2.4% year-over-year. These figures represent the lowest monthly inflation rates recorded by these major economies during the current inflation and interest rate hike cycle.
The U.S. Department of Commerce's report highlighted that within the PCE price index, the prices of goods and food increased by 0.2% and 2.4% respectively, year-over-year. The primary driver of the index increase was the 4.4% rise in service prices. Energy prices, which have been high for nearly two years, decreased by 4.8% year-over-year. The core PCE price index, which excludes energy and food prices, also reached its lowest level during this inflation period with a year-over-year increase of 3.5%.
The slowdown in the year-over-year growth rates of both the U.S. PCE price index and the core PCE price index in October reaffirms the downward trend in inflation. Since the PCE price index reached a low of 3.2% in June, it had rebounded and stabilized at 3.4% over the past three months, prompting institutions including the Federal Reserve to conclude that inflation was stubbornly high.
The EU's statistical report also indicated a rapid decline in Eurozone inflation. The 2.4% year-over-year increase in the price index was a sharp drop from the previous values of 4.3% in September and 2.9% in October, and lower than the expected 2.7%. This marks the second consecutive month that Eurozone inflation has been lower than in the U.S. In the Eurozone, food, industrial products, and service prices increased by 6.9%, 2.9%, and 4.0% respectively, while energy prices, which had troubled the Eurozone, fell by 11.5% year-over-year. The core inflation rate, excluding food and energy, also dropped to a low of 3.6%.
Among major Eurozone countries, inflation rates in Germany, Italy, and the Netherlands were 2.3%, 0.7%, and 1.4% respectively in November, close to or below the European Central Bank's medium-term inflation target of 2%. Belgium even showed signs of deflation with a year-over-year price index decrease of -0.7%, while France and Spain had relatively poor performances with inflation rates of 3.8% and 3.2%.
Since March 2022, the Federal Reserve has raised interest rates 11 times, increasing the federal funds rate to a range of 5.25%-5.5%, the highest level in 22 years. The European Central Bank has also raised interest rates 10 times since July 2022, increasing its three key interest rates - the main refinancing rate, the marginal lending rate, and the deposit facility rate - to 4.50%, 4.75%, and 4.0%, respectively, the highest levels since the currency union's inception.
With the rapid decline in inflation in both the U.S. and the Eurozone, expectations for the Federal Reserve and the European Central Bank to begin cutting interest rates are strengthening.
Bill Adams, chief economist at Union Bank, said that while the Federal Reserve is currently holding steady, they are moving closer to cutting interest rates. Inflation is clearly slowing, and the labor market is weakening faster than expected. Andrew Hunter, deputy chief U.S. economist at Capital Economics, believes the Federal Reserve is likely to start cutting interest rates as early as March next year, sooner than the market expects, with increasing evidence that inflation will approach the 2% target by mid-2024.
Sonu Varghese, a strategist at financial consulting firm Carson Group, noted that the Federal Reserve has acknowledged that inflation is slowing, and with the economy strong and unemployment low, this essentially lays the groundwork for rate cuts.
The unexpected decline in inflation also suggests that the Federal Reserve officials' previous hawkish stance to maintain a tight monetary policy may not have had the expected effect.
John C. Williams, president of the New York Federal Reserve, said on Nov. 30, "If price pressures and imbalances persist beyond my expectations, additional policy tightening may be required." While Williams reiterated in his speech that "the Fed is at or near the highest level of the federal funds rate target range," he also hinted that the Fed might raise rates further if inflation data is not favorable.
Federal Reserve Governor Christopher Waller earlier this week said, "Inflation is still too high, and it's too early to judge whether the economic slowdown we're seeing will persist."
Clearly, the Federal Reserve's attempt to cool expectations of rate cuts has been unsuccessful in light of the inflation figures. On the same day, the Dow Jones Industrial Average rose about 1%, reaching a new high for 2023, while U.S. Treasury bonds were sold off, causing bond yields to rise sharply.
Another data point supporting the nearness of Federal Reserve rate cuts is the number of unemployment claims released by the Department of Labor on the same day, which surged to 1.93 million, the highest level since November 2021. This figure is generally seen as a leading indicator of whether the U.S. economy is entering a recession and has been cited as a main reason for rate hikes in previous Federal Reserve policy decisions.
Compared to the economically active U.S., the European Central Bank faces pressure to cut rates quickly due to the risk of economic recession and inflation data approaching the inflation target.
Among the 20 Eurozone countries, five members, including the Netherlands, Italy, Finland, Belgium, and Latvia, had inflation below the 2% target in November, and six others, including Germany, had inflation below 3% for the month. This not only means that the European Central Bank's previous forecast of 3.2% inflation for 2024 is overly conservative, but it also overlooks the risk of Europe re-entering deflation.
ING Group believes the European Central Bank risks underestimating the deflationary trend, just as it underestimated the rise in inflation two years ago. Jens Suedekum, a professor of international economics at the University of Düsseldorf, said, "The European Central Bank initially underestimated the rise in inflation and is now underestimating the speed at which inflation is disappearing again. It's dangerous for the central bank to keep its interest rate guidance high. If it lasts too long, it will damage economic growth."
The European Commission, in its autumn economic outlook report released on Nov. 16, again lowered its growth forecasts for the EU and the Eurozone for this year and next. The latest report revised the EU and Eurozone GDP growth rates from 0.8% to 0.6% for this year, and to 1.3% and 1.2% for 2024, respectively.
