Syndicated News

Inflation hopes dim despite ECB plans

Days before the European Central Bank is expected to deploy its ultimate monetary easing weapon, financial markets are showing no sign of confidence that it will push inflation anywhere near target in the next decade.

The ECB is expected to launch a programme to print hundreds of billions in new euro by buying government bonds as soon as Thursday, with the explicit aim of boosting inflation. Yet market-implied inflation expectations have fallen relentlessly.

The major driver has been a nearly 60% drop in oil prices since June, hitting the cost of a wide range of goods and services and taking investors and policymakers by surprise.

What is striking, though, is that inflation expectations in the eurozone have fallen at a similar pace to that seen elsewhere, including the US, where the Federal Reserve is expected to tighten monetary policy this year.

Market participants say this is because investors are beginning to doubt the power of quantitative easing as a policy tool. Some even question the ECB’s credibility.

The euro five-year, five-year break even forward, a gauge of the market’s longer-term inflation expectations, has fallen 60 basis points in the past six months and 20 bps this year alone.

The contract, which shows where markets expect 2025 inflation forecasts to be in 2020, trades at record lows around 1.5%, well below the ECB’s roughly 2% goal. Its US equivalent stands at 2.16%, down from 2.33% in December and 2.8%-2.9% half a year ago.

It is expected to rise in Europe a bit once the ECB announces QE, but not by much.

“You can forget getting break evens back to where the ECB wants them to be,” said Ralf Preusser, head of EMEA rates research at BofA Merrill Lynch. “You’ve got to price some probability that it won’t work.

“It is a rational market reaction to the fact all central banks have failed to hit their inflation targets over the past four-five years. The market doesn’t believe that QE is the miracle cure. It can only be part of the solution.”

Nor can the ECB blame the oil price fall for the expectation it will miss this target: by ignoring the first five years of the 10-year period, the measure in theory should not be correlated with commodity prices. The impact of 2014’s drop in oil prices should have long disappeared from inflation numbers by 2020, whether or not crude rebounds.

Credit Agricole strategist Jean-François Perrin said monthly inflation figures have to rise over a sustained period before market-implied expectations increase markedly. Eurozone consumer prices fell in December.

“When QE is delivered we may have the euro getting even lower, oil prices possibly rebounding. So … the five-year, five-year might rebound to 1.6% but I’m not sure at all that it would go back up to even 1.8%,” he said.

Article Source: http://tinyurl.com/kbwqb42

< Back to Syndicated News