What does the future of inflation hold in Europe?

This is no normal economic cycle.

For policymakers, investors or market traders, it's been a bruising few years. Unprecedented shocks and an outsize inflation spike have tied the economics world in knots - mainly trying to assess what will be durable once the dust settles.

Slow to accept a post-pandemic inflation surge was any more than a temporary price re-set after worldwide lockdowns and supply disruptions, public and private forecasters then switched to fearing the Ukraine-related energy jolt would entrench a cost of living squeeze for years and seed significant recessions.

But as impressive US disinflation sweeps through 2023, without a cratering of employment or the wider economy so far, the narrative is shifting again - and encouraging hopes that bruising central bank tightening may be short-lived too.

With a 'soft landing' now majority thinking again, phrases like 'immaculate disinflation' abound and raise questions about whether underlying price dynamics have changed very much after all - even if geopolitical and supply chain maps are redrawn.

"Is 'sticky' the new 'transitory'?" Morgan Stanley strategists asked this week, comparing a much-lampooned descriptor of what was once assumed to be a temporary inflation pop with the word now most often used to frame its persistence.

Whether 'sticky' disappears from the lexicon like 'transitory' did in late 2021, they reckon, hinges on the runes of encouraging recent US price trends and a key speech last week from Federal Reserve governor Christopher Waller - seen as a consensus thinker at the central bank.

Intriguingly, the strategists - Guneet Dhingra and Allen Liu - suggest the Fed may be 'behind the curve' again in spotting the extent to which inflation will fall from here - much like many suspect it was when moving to rein in the original consumer price spike two years ago.

Like many, they home in on the outsized drop in used-car prices - one of the key aggravators of 'core' inflation that at 4.8% is still well above the now sub-3% headline CPI rate.

The 4.2% drop in June used-car prices, along with survey indications of more to come and favourable base effects from last year, could over the coming months see annual core inflation drop below the 'sticky' 4-6% range they've been embedded in since late 2021.

And that in turn may satisfy Waller's condition of two more impressive readings on inflation to stay the Fed's hand on another rate hike beyond this month's near-certain quarter point move - despite his warning last week that the June inflation surprise could yet be one-off.

Pointing to four straight months of ebbing 'trimmed mean' inflation measures of core inflation - which strip out high and low outliers - the Morgan Stanley team doubts June was a bum steer and sees core disinflation as more of "a trend rather than a headfake".

With labour supply increasing, the Fed likely is and should be less concerned about a strong jobs market, they argue.

To be sure, Treasury Secretary and former Fed chief Janet Yellen jived with that take on Tuesday.

Others doubt the optimism, of course.

Barclays economists think the deceleration in core services inflation was flattered by volatile items like airfares and hotel prices that may not be sustained going forward and said tight job markets question progress from here.

"We strongly suspect that June's prints exaggerate disinflationary pressures," they conclude.

Global investors polled by Bank of America this month also seem to suggest the best of the news on lower inflation may be ending as the survey's aggregate expectation of global inflation over the next 12 months has stopped falling.

And yet, even though it declined this month, the survey still shows fund mangers overweight bonds - more than two standard deviations above long term averages.

Of course that positioning is braced for potentially two scenarios - if disinflation optimism proves correct and ends central bank tightening, or if central banks keep raising rates in overkill and force a deep recession and reversal in time.

And it's the latter that homes in on the prospect of an inflation undershoot.

It raises the question of how much of Fed tightening has yet to hit, with Waller's presumed lag of 9-12 months in mind, and also the thorny issue of where exactly the theoretical and elusive 'r-star' natural interest rate - consistent with sustainable growth and low steady inflation - actually lies.

With 10-year real or inflation-adjusted interest rates in the Treasury market briefly touching the highest in almost 14 years earlier this month at 1.8390% and the current real policy rate now more than 2%, both are already well above most recent Fed estimates of 'r-star' around 1.14%.

And significantly, those modelled Fed estimates are still actually lower than they were just before the pandemic hit - undercutting arguments to suggest economic equilibrium has changed structurally.

Further Fed tightening after this month, then, could well see markets start to consider inflation actually undershooting 2% targets after all - but dragging recession back onto the dashboard to boot.