Inflation is declining more rapidly than expected across advanced economies, marking a significant shift in central banks’ multi-year struggle against high prices. This trend is evident in major economies like the U.K., U.S., and eurozone, where inflation rates have dropped to around 3-5%.

The cooling of inflation rates is fueling expectations that central banks might pivot from aggressive interest rate hikes to rate cuts as early as next year. This shift would relieve the global economy, especially Europe, which is teetering on the edge of recession.

Yields on government debt in Europe and the U.S. have declined as investors anticipate potential interest rate cuts. The recent evidence suggests that the high borrowing costs are starting to impact economic growth and inflation significantly.

The sharp declines in inflation can be attributed to common factors like the COVID-19 pandemic and the Russia-Ukraine conflict, which disrupted supply chains, reduced workforce numbers, and spiked energy prices. As these forces recede, inflationary pressures are naturally subsiding.

Despite these declines, underlying inflation remains robust due to demand-side factors like government stimulus spending in the U.S. and accumulated consumer savings during the pandemic. This necessitated rate hikes to control inflation.

Even the U.K., where inflation has been particularly stubborn, is showing signs of progress. October saw consumer prices rise by 4.6%, down from 6.7% in September, indicating the slowest increase since October 2021.

Following the U.K.’s lead, the U.S. reported a significant drop in inflation to 3.2% in October. The eurozone also reported a decline to 2.9% from 4.3% in September. Some European countries even reported consumer prices lower than a year earlier.

European policymakers are increasingly convinced that inflation is under control, and the battle against it has been shorter than in previous crises like the 1970s. Investors are now pricing in interest rate cuts by major central banks in the coming year.

Despite the optimism, central banks remain cautious. The persistence of inflation last year was a surprise, and they are wary of wage growth and potential energy price hikes. Central banks like the Bank of England forecast to reach their inflation targets by late 2025.

Economists observe that interest rate hikes are gradually affecting the economy, with a slowdown in job creation and rising unemployment. U.S. retail sales and eurozone industrial output have shown declines. However, there’s a growing consensus that inflation is waning and lower interest rates will follow in 2024.

Europe faces more economic challenges than the U.S., with the potential for deeper downturns and sharper inflation drops. This could lead to earlier rate cuts by the ECB. Despite prospects of lower rates, a return to ultra-low pre-pandemic levels seems unlikely due to geopolitical tensions and demographic changes.