Aurelia Butler

FRANKFURT (Reuters) -Euro zone inflation jumped as expected last month, supporting the European Central Bank’s case to keep interest rates at record highs for some time, even as markets continued to bet on a rapid fall in borrowing costs.Inflation across the 20-nation bloc jumped to 2.9% in December from 2.4% in November, just shy of expectations for a 3.0% reading, mostly on technical factors, such as the end of some government subsidies and low energy prices getting knocked from base figures. The data is in line with the ECB’s prediction that inflation bottomed out in November and will now hover in the 2.5% to 3% range through the year, well above its 2% target, before falling to target in 2025. Still, figures suggested that the structure of inflation is changing and while base and fiscal effects could yank around the headline figure, overall pressures may be easing. The focus now turns to how wage settlements and global political tensions are impacting prices, two factors that could have longer-term consequences.Wage deals are finalised in the first quarter in much of the euro bloc but data is not available until May, so policymakers will need perhaps until mid-2024 to get a reliable picture.Geopolitical tensions are harder to predict. While the war in Gaza has had little effect on energy prices so far, the more recent disruption of shipping via the Suez Canal has pushed up transportation costs.This in itself is not a big factor for prices but it could lift inflation if goods take longer to reach Europe over an extended period and shortages develop. “Where higher costs are shipping specific, as at the moment, the inflation impact is very small,” Paul Donovan at UBS Wealth Management said.”It is not the value of goods shipped, but the changing cost of shipping the goods that matters. Globally, shipping by sea accounts for less than 0.3% of global economic activity.”EXPECTATIONSThe inflation jump comes as investors and policymakers appear to be drawing different conclusions about price trends and their implication for interest rates.Investors are betting that the ECB will cut rates six times this year with the first move coming in March or April while policymakers argue that it might take until mid-2024 to gain the confidence that inflation is indeed under control. “Inflation is far from being defeated,” Commerzbank (ETR:CBKG) economist Christoph Weil said. “The ECB is likely to cut its key interest rates significantly less than the market currently expects.”A key source of the divergence in views is that the ECB’s own inflation projections have been off for years, suggesting that the bank does not have a full understanding of price-setting behaviour in exceptional circumstances. During the post-pandemic inflation surge, the ECB first predicted just a transitory rise in prices, then a shallower peak, and finally a much slower reversal. This led some policymakers to raise their focus on reported data and lower the emphasis on projections. Nordea economists Anders Svendsen and Tuuli Koivu think the ECB is wrong again and they see inflation below 1.5% by the end of the summer, well below the ECB’s own projections.”If inflation prints continue to come in on the soft side, risks of an earlier cut and/or a faster pace of cuts compared to our current baseline of quarterly 25bp rate cuts increase,” they said, adding that the first cut could come in June.Investors argue that the ECB is too optimistic on growth and also point to a sharp drop in producer prices — down 8.8% in November — as evidence of cooling price pressures.Markets are also betting on aggressive rate cuts from the U.S. Federal Reserve and investors think that once the world’s biggest central bank moves — in March or May — the ECB will want to move in sync. More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.Eurozone inflation rose to 2.9 per cent in December, reversing six months of consecutive falls and raising questions over how soon the European Central Bank would start cutting interest rates.The annual rise of consumer prices in the 20 countries that share the euro in December was up from a more than two-year low of 2.4 per cent the previous month, but was slightly lower than the 3 per cent rate forecast by economists in a Reuters poll.The reduction of government subsidies on gas, electricity and food that began last year has triggered a re-acceleration of annual inflation in much of Europe. This has led investors to scale back their bets that the ECB will start rate cuts as early as March, putting a dent in a recent rally in bond markets.But most economists believe eurozone inflation will soon start to fall again. December’s pick-up in price pressures was “just a blip”, said Capital Economics’ Jack Allen-Reynolds, forecasting it would “be reversed in January due to further declines in food and core inflation”.The ECB, which is due to meet to discuss monetary policy on January 25, pushed back against investor expectations of imminent rate cuts last month, saying it wanted to see signs of wage pressures cooling to be sure inflation was on track to hit its 2 per cent target.A mild sell-off in eurozone government bond markets continued in response to Friday’s figures. Germany’s rate-sensitive two-year bond yield was up 0.05 percentage points at 2.59 per cent. Bond yields rise as their prices fall.Diego Iscaro, an economist at S&P Global Market Intelligence, said: “We still believe that market expectations of a first cut coming in March may be too early, as the ECB will want to have more evidence of a moderation in wages before pulling the trigger.” Eurozone energy prices fell 6.7 per cent in the year to December, compared with an annual decline of 11.5 per cent in the previous month, according to the harmonised index of consumer prices published by Eurostat on Friday.Fresh food prices accelerated in December, rising 6.7 per cent compared with 6.3 per cent in the previous month. The pick-up in inflation reflected the comparison with a year earlier when several governments — including those in Germany and France — heavily subsidised gas, electricity and food costs, which drove down the cost of household bills temporarily. Core inflation, which excludes volatile energy and food prices to give a better picture of underlying price pressures, slowed from 3.6 per cent in November to 3.4 per cent in December. Services inflation, which is closely tracked by the ECB to see the impact of rising wages, was flat at 4 per cent. More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.Economists believe the US jobs market weakened in December, bolstering the case for the Federal Reserve to consider cutting interest rates. A poll by Reuters showed economists, on average, predict data published on Friday will show the US economy added 170,000 jobs in December, down from 199,000 in November. The economists also say the number of non-farm payrolls, collated by the Bureau of Labor Statistics, will show a small rise in unemployment to 3.8 per cent in December, up from 3.7 per cent a month earlier. The jobs data, due out at 8.30am Eastern time, is a crucial metric for the Fed as its officials assess the health of the US economy — and Friday’s monthly update comes as economists and rate-setters debate how quickly and when the central bank should cut interest rates.Other employment data published by the BLS earlier this week showed the number of new job openings across the US in November fell to its lowest level in two years. Despite the signs of a slowdown in job creation, the December figure would cap a much better than expected year for the US labour market. “We’re likely to have added over 2.7mn jobs over the course of 2023, which would be the strongest performance since 2015 if you exclude the Covid disruptions,” said Gregory Daco, chief economist at EY. “It’s an indication of the robustness of the labour market.” The big question for 2024 is whether a slowdown in the labour market can continue to cool with only minimal impact to the broader economy. The Fed is betting on only a small rise in unemployment to 4.1 per cent by the end of 2024. Officials believe a rise of that magnitude would help lower inflation towards their 2 per cent goal without crashing the economy, paving the way for them to cut rates later this year. The latest projections from US central bank officials, published in December, show they expect the Fed to lower borrowing costs by 75 basis points over the course of 2024.However, some economists are doubtful that such a soft landing for the jobs market can be achieved. “The least likely scenario, in my mind, is that the unemployment rate will gradually drift higher,” said Drew Matus, chief market strategist at MetLife Investment Management. “I am predicting a shallow recession during the first half of this year. And in the past, when we’ve had a recession, we’ve seen the unemployment rate move higher fast.” “The idea underlying the Fed’s message is that the labour market will just slowly weaken over time,” Matus added. “That’s usually not the way it behaves.” Additional reporting by Kate Duguid in New York More

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