Alan Greenspan, former chairman of the Federal Reserve, once warned about fear and euphoria. Especially because these two forces could not be captured by economic models. Central banks face the last Mille in their battle against rising prices trying to escape from those two sensations: they neither want to claim victory nor let themselves be carried away by fears of a recession. However, markets are already beginning to discount that the rapid decline in inflation, especially in Europe, and the entry into a period of anemic growth will force the Federal Reserve and the European Central Bank (ECB) to lower interest rates. sooner than expected, even starting in spring 2024. Experts also warn that the ECB could be ignoring the speed with which prices are falling, which could depress the euro zone economy more than necessary.
“When the facts change, I change my mind.” Isabel Schnabel, a member of the most orthodox wing of the ECB, used Keynes to explain in an interview with Bloomberg her most optimistic vision of the fight against inflation, which in November stood at 2.4% in the area as a whole. euro. The German considered it a “very pleasant surprise.” And that change in language consolidated the markets' belief that interest rates will drop in 2024, even to 2.5%. Investors consider, therefore, that the much-feared last mile to reach the 2% inflation target will not be as costly as previously believed.
After the Federal Reserve published its rate cut forecast for 2024, Frankfurt tried to stop the euphoria that Greenspan considered so pernicious. The president of the ECB, Christine Lagarde, maintained on Thursday that the council has not at any time discussed lowering rates. “It is like the solid, liquid and gaseous states: you do not go from solid to gaseous without going through the liquid phase,” said the Frenchwoman. The markets calmed down at first, but even in that phrase they saw Lagarde's calculated ambiguity: bodies can go from solid to gas through sublimation. On Friday, the debt markets fell again—Spanish debt stood at 3%, one point less than just two months ago—and the Euribor continued its downward trajectory, giving breathing room to governments and families.
The data that is arriving reinforces investors' projections. International organizations see Europe as the most lagging economic bloc, with Germany and France dragging their feet; Salaries are still far from recovering the lost purchasing power, and energy costs continue to decline despite the war in Ukraine. Frankfurt, in fact, lowered its growth forecasts for the euro zone in 2023 and 2024. “Slowly, [el BCE] is laying the groundwork for future interest rate cuts. Specifically, we expect it to begin doing so in June 2024, although they could occur earlier, in March, given the risks to the growth outlook and the possibility that disinflation continues at a rapid pace,” says Nadia Gharbi, economist from the manager Pictet WM.
It's not just Schnabel who has taken a clear turn in his tone. Some member of the council, such as the French governor, François Villeroy de Galhau, stated in The Dépêche du Midi that the process of “disinflation is occurring more rapidly” than they believed. “Except shocks, there will not be a new rate increase. The question of a rate cut could be raised in 2024, but not now,” she added. To curb market speculation, the governor of the Central Bank of Slovakia, Peter Kažimír, stated through his Twitter account that while the data indicates that no further adjustments will be necessary, a cut in the first quarter of 2024 is “ Science fiction”. However, the markets have never predicted reductions at the beginning of the year.
Experts believe that the ECB may be trailing behind what is happening in the real economy. “During 2020 and 2021, we criticized the temporal theory of the central banks, as they stated that they should remain inactive because inflation was going to rise and fall on its own. In late 2021 or early 2022 they gave up and started raising interest rates, just as inflation peaked. Since then, inflation has fallen steadily, long before interest rate increases had any impact,” criticizes Charles Wyplosz of the Graduate Institute of Geneva.
Danger of making mistakes in forecasts
“Disinflation is going faster than most economists predicted,” agrees London School of Economics professor Paul De Grauwe. “The ECB is underestimating the speed of current disinflation. There is little evidence that the last Mille be the most difficult. The ECB is now making the same mistake as when inflation increased. “Then it underestimated the speed of the increase in inflation, while now it underestimates the speed of the fall,” the economist points out.
The problem is above all that the heavy hand of the Eurobank can further depress the economy. The center stage remains a soft landing. “The inflation we are experiencing now will disappear without the need to experience a recession. A recession would really be a failure of the central banks,” says De Grauwe. Wyplosz also regrets that the ECB ends up giving in to the markets, since it would be a blow to its credibility. “Monetary policy is now scathing, just as inflation approaches the 2% target. If this view is correct, inflation will continue to decline while growth will stagnate. Once again, central banks will have to relent on their previous statements and quickly cut their interest rates,” he maintains.
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