Falling Global Inflation Has Investors Betting on Rate Cuts

November 16, 2023

Inflation has been falling faster than expected throughout the world’s developed economies, giving some investors reason to hope that central bankers may be about to pivot away from the tight monetary policies they adopted to combat inflation.

Inflation has fallen to below 5% in the U.K. and is around 3% in the U.S. and Eurozone, fueling expectations that central banks could be done putting the brakes on their respective economies and pivot to cutting interest rates next year. That would be welcome news for a global economy that, aside from the U.S., has struggled with anemic growth amid higher rates.

Economists have been puzzled for months over why rapidly climbing interest rates have not done more to slow growth and inflation and worried that rates would need to climb higher or remain elevated for a prolonged period, but the recent data suggest that “lagging and variable” impact of higher rates has finally caught up to the economy.

The Federal Reserve has been reticent to declare victory over inflation, maintaining a “wait and see” approach and forecasting a series of gradual rate cuts over the next 2-3 years. Other central bankers appear more willing to declare the battle won. France’s European Union finance minister Bruno Le Maire has said that the economic bloc is “in the process of exiting the inflationary crisis.”

Investors appear to be optimistic that inflation is waning and expect rate cuts to come sooner rather than later. They are pricing in interest-rate cuts by the Federal Reserve and European Central Bank starting next spring, and by the Bank of England next summer, according to data from Refinitiv. Following the release of the latest CPI inflation report, the markets were pricing in just a 5% chance of another rate hike from the Fed, down from a 30% probability the day before. Moreover, the likelihood of an interest rate cut by May jumped from just 23% to 86%, suggesting that market participants overwhelmingly believe that inflation may finally be stomped out.

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