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A little over a month ago, global bond yields were pushing fresh 16-year highs. US 10-year government bond yields were approaching 5%, up from around 3.75% in mid-July. The sell-off in bond markets, driven by higher real yields weighed on global equity markets, which declined almost 10% between their recent peak at the end of July until late October.
A month can be a long time in financial markets. Fast forward to today, and we’ve seen a significant retracement in bond yields. US 10-year government bond yields have fallen around 60bps to be 4.33% at the end of November. Similarly, global equity markets have recovered and at the end of November stood just 1% shy of their July peak.
One of the key factors behind the recent decline in bond yields has been improving signs on global inflation. After a series of disappointments in FY23, the past month has been characterised by some surprisingly swift moderation in inflation rates across the globe. Europe is leading the way, where this week the euro area headline inflation rate was reported to have fallen to 2.4% in November, a stark contrast to the peak of 10.6% in October last year. The US isn’t far behind, where the CPI inflation rate has fallen to 3.2% in October down from a peak of 9.1% in June 2022. The UK, long the laggard in the global inflation story, has also been moderating more quickly than expected with inflation falling to 4.6% in October, down from a peak of 11.1% In October 2022.
Part of the recent moderation in inflation rates relates to falling energy prices. The recent pull-back in global oil prices is leading to lower gasoline prices across the world. Europe is also benefitting from an abatement of the energy crisis caused by the Russia/Ukraine war, with the sharp drop in natural gas prices since H2 2022 starting to feed more significantly through to retail prices. Base effects are also playing a role, given the height of the European energy crisis was around October/November last year. Falling consumer energy prices, which are down by 15.7% in the UK, 11.5% in the euro area and 4.5% in the US over the past year are clearly helping to lower headline inflation rates.
While the drop in energy prices has been welcome, the promising trends evident in core inflation rates, which exclude food and energy prices, has been far more important. The core CPI inflation rate eased to 3.6% in the euro area in November, to 4.0% in the US in October and to 5.7% in the UK in October. Although still elevated and well above the central bank targets, recent momentum has been much more encouraging. Seasonally adjusted annualised core CPI inflation over the past six months moderated to 2.3% in the euro area, 3.2% in the US and 3.7% in the UK.
Given the restrictive monetary policy stance, we expect the moderation in core inflation rates to continue, although they are unlikely to reach central bank targets until 2025. Under our latest projections, we expect core CPI inflation rates in the US to fall to 2.5% by Q4 2024 and 2.2% by Q4 2025 (which is consistent with the 2% PCE target), to 2.6% and 2.0% respectively in the UK, and to 2.3% and 2.0% respectively in the euro area.
With current underlying inflationary pressures remaining above target, central banks will need to keep policy rates restrictive for an extended period. Although we think it is too premature to consider rate cuts, as we move through 2024, central banks are likely to become increasingly assured that core inflation is on track to return to target by 2025. If the moderation in core inflation continues, we expect the major central banks will pivot in mid-2024 and begin to shift towards a gradual monetary policy easing cycle. This is broadly in accordance with current market pricing, which is pricing in rate cuts to start by the ECB, Fed and BOE between April to August 2024.
Australia, on the other hand, remains behind other major economies in our progress on lowering inflation. The good news this week was that the monthly CPI indicator reported a faster-than-expected moderation in headline inflation to 4.9% in October. This, along with falling retail sales in October, should ensure that the RBA keeps policy unchanged at 4.35% at its meeting next week. The bad news is that our headline inflation rate remains above our advanced economy counterparts and our core (trimmed mean) inflation rate at 5.3%, is also above that seen in the US and euro area. Although core inflation is also expected to return to the RBA’s 2-3% target range during 2025, the slower progress on lowering inflation in Australia, means the RBA will need to keep rates restrictive for much longer. While we don’t expect further hikes by the RBA, rate cuts domestically are a distant prospect, most likely at least a year away.