European Doves Are Too Stretched
Excessively dovish US rate expectations have retraced on resilient data in recent weeks, with the easing focus shifting to Europe. Consecutive rate cuts from the ECB and surprisingly steep disinflation in the UK caused those dovish moves to extend. Both cutting cycles are now close to the Fed’s in a substantial shift from previous expectations. That doesn’t mean the new dovish pricing is more correct in Europe than in the US. Labour market resilience is more extreme in Europe than in the US, which is no less relevant to the medium-term inflation outlook. The priced possibility of December cuts of 50bp for the ECB and another 25bp for the BoE looks stretched.
Among the resilient UK activity releases this week, the unemployment rate dropped by 16bps in August to 4.0%, sustaining a 0.2pp fall on last year. Short-term unemployment looks even tighter as demand trends briskly. Resurgent employment and hours worked hawkishly drive the cyclical tightening while redundancies remain low and weekly vacancies trend slightly higher. Slowing wage growth provides an excuse for the BoE to cut again in November but not to accelerate easing or to extend it. A policy reversal may be needed in 2025 (see UK Cycle Tightens As Policy Eases).
Surprisingly soft UK inflation data extended across the headline and conventional core metrics, partly because of substantial payback in airfares after August’s surge. Only a slight unwind in October and ambiguous historical precedents for November mean much of this downside persists. However, other underlying signals were resilient. The BoE can focus on this downside news and cut in November. Ultimately, signals for the underlying pressures in the cyclically tight UK economy should urge an early pause (see UK Inflation Hits Its Bouncy Bottom).
Soft Euro area headline and services inflation were trimmed further in the final prints for October, reinforcing the disinflationary imperative in the ECB’s decision to cut rates again. The news on underlying inflation was mixed between countries and measures. Things broadly remain close to target-consistent levels but need not stay like that. We remain concerned about potential over-extrapolation and focus on disinflationary data points. However, that seems unlikely to change in time to block a 25bp December cut (see EA Disinflates Enough For October Cut).
Surprisingly steep disinflation and drops in the PMIs shocked expectations for the ECB’s October meeting, which were matched by the realised 25bp rate cut. The coherent story of disappointment magnified the strength of the signal enough for the ECB to act. Much more data will be available by the December decision. No commitments were made to act or not, but the hurdle is lower when there is a new forecast to communicate the totality of the news. We expect another cut in December before the pace slows (see ECB: Cuts On Coherent Dovish Signal).
Meanwhile, rate cuts have continued elsewhere. Central banks delivered the expected 25bp reductions in Chile and the Philippines, while Thailand surprisingly joined in with one too. The latter has been under considerable political pressure to start reducing rates. Indonesia cut last month, so its decision to hold rates was unsurprising. However, such pauses seem to run against the grain of market pricing in many other countries, including Canada’s 50bp cut priced for next week. That neither makes forceful nor consecutive cuts advisable elsewhere nor negates the risk that the easing proves excessive and needs reversing.