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Closely watched gauges of long-term inflation expectations in Europe have reached their lowest levels for almost two years, in a sign that investors think central banks can keep lowering interest rates without risking a flare-up in price pressures.
The eurozone’s so-called five-year, five-year forward inflation swap — a measure of markets’ assessment of price growth over the second half of the next decade — dipped below 2.1 per cent this week for the first time since October 2022, falling from more than 2.3 per cent last month.
Meanwhile sterling’s equivalent inflation swap — which tracks retail prices that tend to increase by a percentage point more than consumer prices annually — has fallen to 3.2 per cent, down from 3.5 per cent in April and close to its lowest level since 2016.
“It’s a big move” said Tomasz Wieladek, chief European economist at T Rowe Price. “I think investors are moving away from stagflation fears to expectations of a demand-driven slowdown.”
Concern around inflation has ebbed as investors focus on global recession risks, particularly after a weak US labour market report in early August prompted a big rethink in the outlook for rate cuts by the Federal Reserve.
US inflation expectations have also fallen in recent weeks, with markets pricing the average long-term inflation rate at 2.4 per cent, down from 2.6 per cent in July. Traders have been boosted by the Federal Reserve recently describing the incoming data as “enhancing their confidence” that inflation was moving towards its 2 per cent target.
“Growth data has been on the weaker side and the disinflation trend seems intact,” said Mohit Kumar, chief European strategist at Jefferies. “Both suggest less inflation pressure.”
Figures on Thursday also showed Eurozone wage growth slowing sharply in the second quarter, strengthening the case for the European Central Bank to deliver its second quarter-point rate cut for the year next month.
Negotiated Eurozone pay in the quarter rose 3.6 per cent compared with the same period last year, down from the 4.7 per cent annual growth rate in the previous three-month period.
“In Europe the negotiated wage data was a factor in mollifying any possible earlier concern regarding persistent wage pressures,” said Richard McGuire, head of rates strategy for Rabobank.
UK wage growth, which has contributed to stubbornly high inflation in the service sector, has also shown signs of slowing, with the annual rise slowing to 5.4 per cent in the three months to June from 5.8 per cent the previous month.
A drop in inflation expectations has also tracked a fall in global commodity prices, led by oil and gas and key metals including copper and iron which has dragged Bloomberg’s commodity index down by more than 10 per cent since May.
Analysts said slowing demand from China for key commodities was helping to lower inflation expectations across the world.
“Not only does China make things like cars much more cheaply, the economy is slowing down and that creates excess capacity in things like steel, which they then try to export,” said Wieladek, adding that demand for European luxury goods was also lower.
Although inflation expectations have come down, analysts warn that they are likely to remain volatile. Ageing populations in Europe and shrinking workforces could add to wage pressures in the long term, with the likelihood of labour shortages in the UK “more significant,” according to Rabobank’s McGuire, owing to immigration restrictions imposed by Brexit.
Fiscal demands including calls for higher defence spending and massive investment needed to fund the climate transition could raise public spending and add to inflationary pressures, said analysts.
“I do think inflation is coming down but . . . one thing that worries me is fiscal policy,” said Kumar of Jefferies. “Below 2 per cent is maybe an early 2026 story.”
