Recent rhetoric from key figures at the ECB (Schnabel, Lane) suggests that the drop in inflation below 3 percent for the first time since 2021 should not provide too much of a sense of security regarding its permanent decline, writes HUP’s chief economist Hrvoje Stojić.
High uncertainty surrounding strong wage growth across the euro area and potential new shocks in the energy market deserves attention in assessing the potential for renewed inflationary shocks. Following an unexpected GDP decline in the euro area in the third quarter of -0.1 percent, however, market expectations regarding interest rate cuts of 75-100 basis points in the second half of 2024 have risen.
In today’s times, we are therefore not facing the usual increase in interest rates that will sooner or later be reversed through rate cuts, adds Stojić.
Instead, after years of zero and negative interest rates, Western countries are facing a completely different interest rate regime. Many business models are no longer sustainable as the profitability threshold has permanently increased. Companies must compete for capital again and deal with higher interest rates. The adjustment to the new interest rate regime will take much longer than with the usual increase in interest rates.
Therefore, it is likely that economic weaknesses will last unusually long and characterize both 2024 and 2025. Under such conditions, the most likely scenario is one of gradual recalibration of interest rates downward, but not too quickly given the uncertainty regarding inflation trends.
