Last week, we heard the latest on the inflation situation in Europe – one of the biggest economic regions. While Australia isn't Europe (except when it comes to Eurovision!), it might be helpful to look at the data and a reaction that could influence the S&P/ASX 200 Index (ASX: XJO).
Europe inflation
As reported by various media outlets, including CNBC, Eurozone inflation was 2.4% (down from 2.9% in October) on an annual basis, with core inflation of 3.6%. The 2.4% number was lower than the 2.7% expected by economists polled by Reuters.
The core inflation, which excludes volatile items like fuel, was 3.6%, down from 4.2% in October.
While this improving picture doesn't mean interest rates are about to drop in the next month or two, it shows the European Central Bank is making good progress, and rate cuts may occur next year.
The European share market rose by 7.50% in November, a strong return in just one month and brought the STOXX Europe 600 (INDEXSTOXX: SXXP) close to its 2023 high. Investors seemed pleased with the inflation news.
Why do interest rates matter for (ASX 200) valuations?
As Warren Buffett once said:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be.
So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.
Lower inflation may bring interest rates stabilisation and cuts closer.
How does this affect the ASX 200 Index?
Australia's rate of inflation is currently much higher than Europe's. According to the Australian Bureau of Statistics (ABS), the monthly CPI indicator showed that inflation rose 4.9% in the 12 months to October 2023 in Australia.
The annual movement for the monthly CPI, excluding volatile items and holiday travel, rose 5.1% in October, down from 5.5% in September 2023.
The RBA wants to bring the Australian inflation rate down to between 2% to 3%, so there's still a lot of work to do. It's possible the RBA may need to increase rates again, according to Morgans' chief economist Michael Knox.
However, it appears the Australian inflation rate has peaked and is reducing.
Strengthening share markets in Europe (and the US) could be a boost for the ASX 200 Index because the Aussie market usually follows the direction of northern hemisphere share markets to some degree.
In the long term, I think a number of ASX 200 shares can keep growing profit, which is a useful tailwind for share price and dividend growth.
