Les prescriptions médicales de la BCE vue par Thomson Reuters
The 5y5y (5y rate in 5 years) forward inflation swap rate in the Eurozone has continued to move into record low territory.
This has been a favoured measure of medium term inflation for the ECB according to ECB President Draghi at his 2014 Jackson Hole speech that laid the foundations for current ECB QE.
However, a much more worrying development is happening further along the inflation swap curve with 10yr and 30yr swap rates seeing lower-lows for the cycle (see http://link.reuters.com/jeq63w).
What will be a concern for the ECB is that these swap rates are moving further away from the 2% target suggesting that current low inflation is far from just a temporary energy/food related phenomena.
The prospect of lowinflation becoming more entrenched is a worry as it does not take much of a shock to shift from a low inflation environment to deflation.
While 2-months ago the prescription was seen as "more QE, more NIRP" it is far from clear that such a strategy will help to build market confidence especially with regards to the health of the financial system.
What central bank policies have so far demonstrated is their ability to influence asset prices with little in the way of a lasting impact on growth or inflation. We suspect that the ECB will stick with the current script and cut the deposit rate by 15bps and expand QE by a further EUR30bn when it meets in March.
Dr Draghi will likely tell us that "If the medicine is not working just take more of it and we promise it will eventually work"
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