Long-term inflation expectations in Europe have reached their lowest point in nearly two years, indicating that investors believe central banks can continue lowering interest rates without triggering renewed inflationary pressures.
The eurozone’s five-year, five-year forward inflation swap—a key measure of market expectations for price growth in the latter half of the next decade—dipped below 2.1 percent this week for the first time since October 2022. This is a significant drop from the more than 2.3 percent level recorded last month.
Similarly, the UK’s equivalent inflation swap, which tracks retail prices that typically rise by one percentage point more than consumer prices each year, has fallen to 3.2 percent. This is down from 3.5 percent in April and close to its lowest level since 2016.
“This is a substantial shift,” said Tomasz Wieladek, chief European economist at T Rowe Price. “Investors seem to be moving away from concerns about stagflation and are now anticipating a slowdown driven by weaker demand.”
The easing of inflation fears comes as investors increasingly focus on the risks of a global recession. This shift in sentiment was notably influenced by a weak U.S. labor market report in early August, which led to a significant reassessment of the Federal Reserve’s rate cut outlook.
In the U.S., inflation expectations have also decreased in recent weeks, with markets now pricing the average long-term inflation rate at 2.4 percent, down from 2.6 percent in July. The Federal Reserve’s recent statements expressing confidence that inflation is moving towards its 2 percent target have further supported this trend.
“Growth data has been weaker, and the disinflation trend appears to be continuing,” said Mohit Kumar, chief European strategist at Jefferies. “Both factors suggest reduced inflationary pressure.”
Data released on Thursday also showed a sharp slowdown in wage growth across the Eurozone in the second quarter, bolstering the case for the European Central Bank to implement its second quarter-point rate cut of the year next month.
Negotiated wages in the Eurozone rose by 3.6 percent in the second quarter compared to the same period last year, a significant drop from the 4.7 percent annual growth rate recorded in the previous quarter.
“In Europe, the latest wage data has helped ease earlier concerns about persistent wage pressures,” said Richard McGuire, head of rates strategy at Rabobank.
In the UK, wage growth—which has been a key factor in sustaining high inflation in the service sector—has also shown signs of slowing. The annual wage increase slowed to 5.4 percent in the three months to June, down from 5.8 percent in the previous month.
The decline in inflation expectations has coincided with a drop in global commodity prices, led by decreases in oil, gas, and key metals such as copper and iron. Bloomberg’s commodity index has fallen by more than 10 percent since May.
Analysts attribute the drop in inflation expectations to slowing demand for key commodities from China, which has been a major factor in reducing global inflationary pressures.
“China’s economic slowdown is creating excess capacity in industries like steel, which they are then exporting,” said Wieladek. He also noted that demand for European luxury goods has decreased.
Despite the recent decline in inflation expectations, analysts caution that they may remain volatile. Ageing populations and shrinking workforces in Europe could exert long-term wage pressures, with the UK particularly vulnerable due to immigration restrictions imposed by Brexit, according to Rabobank’s McGuire.
Fiscal pressures, including the need for higher defense spending and massive investments required for the climate transition, could also drive up public spending and contribute to inflationary pressures, analysts warn.
“I do believe inflation is decreasing, but fiscal policy remains a concern,” said Jefferies’ Kumar. “Achieving below 2 percent inflation might only be realistic by early 2026.”
