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Inflation Rising, Rate Cuts Postponed

The rebound in inflation, the conflict in the Middle East and the supply difficulties caused by the attacks in the Red Sea are not likely to reassure central banks. Interest rate cuts will have to wait, much to the chagrin of investors.

By EC Invest

The euro area and the United Kingdom ended 2023 with higher inflation rates than the previous month.

In the euro area, inflation was 2.9% in December compared to 2.4% in November. There are three main reasons for this: first, the price of untreated food has risen sharply and, at +6.8% year-on-year, is experiencing its most substantial increase since August. At the same time, service prices are not falling and are up 4% year-on-year, just like the previous month.

Finally, while energy prices have contributed to the decline in inflationary pressures in recent months, the conflict in the Middle East has put them back under pressure, making their one-year decline less significant. This phenomenon is not exclusive to the euro area. In the United Kingdom, inflation follows the same trend, rising from 3.9% in November to 4.0% in December. The same was true in the United States, which reported higher inflation (3.4%) the week before.


The danger of a more significant conflict in the Middle East and the supply difficulties caused by the attacks on maritime transport in the Red Sea is not to calm minds, adding a layer of uncertainty and the possibility of inflation that would not go back as expected.

This is terrible news for bond and equity markets. The latter had anticipated many policy rate cuts in 2024, synonymous with cheaper credit and stronger economic activity. So, the price of bonds has gone up, as has the price of stocks. However, the major central banks have never confirmed such a scenario and have been cautious, faced with the idea of lowering their rates too early and quickly, which could boost inflation.

Investors have long resisted, thinking that they would eventually be right. But the rebound in inflation and tensions in the Middle East and the Red Sea, which are hurting the supply chains between Asia and Europe, on the contrary, is giving the central banks arguments, reinforcing their prudence. In addition, by exaggerating their expectations of rate cuts, markets end up easing credit conditions that do not contribute to the desired outcome by central banks, which could even force them to keep restrictive monetary policies longer.

Ultimately, if everyone agrees that rates are at a peak, the rate cuts investors expect will not be forthcoming. This explains the turbulent days in the financial markets.

The latter must readjust their attacks because monetary policy will not become expansionist overnight; we must be patient, and some have probably been too far in their bets for 2024.

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