World Economy

ECB Stimulus Helps Prevent Deflation

ECB Stimulus Helps Prevent DeflationECB Stimulus Helps Prevent Deflation

Analysts at Mizuho International Plc and Royal Bank of Scotland Group Plc stepped up calls for more monetary stimulus as an indicator of the eurozone’s inflation outlook derived from forwards languished near a three-month low.

The five-year inflation swap rate–which measures the five-year price-growth outlook five years from now–fell this week to the lowest since October. The market turmoil spreading from China since the start of this year is weighing on the measure, which strategists say is heaping pressure on the European Central Bank to act, Bloomberg reported.

ECB officials led by President Mario Draghi will increase the pace of their bond-purchase program at March’s policy meeting, according to Peter Chatwell, head of rates strategy at Mizuho in London. RBS predicts 0.4 percentage point of cuts to the central bank’s minus 0.3% deposit rate, and sees the region’s bonds rallying as a result.

ECB Chief Economist Peter Praet wrote in a guest commentary in the Sueddeutsche Zeitung newspaper on Tuesday that slow inflation was damping the longer-term outlook and that there’d be no change to the policy of targeting price growth of just under 2% a year.

 Dovish Overtures

“We expect to hear further dovish overtures from key governing council members, such as Praet and Draghi, over the coming month,” Mizuho’s Chatwell wrote in a note on Wednesday. In March, “we expect the ECB to increase the pace of the public-sector purchase program. If they do not, we expect inflation expectations will fall even further.”

The ECB’s rate cut and extension to quantitative easing at its meeting last month fell short of some investors’ expectations, sending German 10-year bund yields surging from near a seven-month low.

The yield on the bund maturing in August 2025 fell two basis points, or 0.02 percentage point, to 0.52%. The 1% security rose 0.14, or €1.40 per €1,000 face amount, to 104.49.

 QE Extension?

Meanwhile, Goldman Sachs Group Inc. Francesco Garzarelli, London-based co-head of fixed-income strategy at the bank, believes that the European Central Bank would go for QE expansion rather than slashing rates in the future. Garzarelli also added that the QE may extend well beyond March 2017.

“The ECB is probably in the direction of more QE rather than more negative rates,” he said. “The deposit rate gets you a weaker euro and a boost to inflation quicker, but it has a political cost domestically and internationally.”

On the other hand, asset purchases address the “bigger problem of Europe” by freeing governments to follow through with structural reforms. “The more of that debt gets onto the central bank balance sheet, the more of it becomes sustainable.”