Draghi Makes His Voice Heard as Inflation Expectations Rebound

22 Jun 2019, 09:33 PM IST

(Bloomberg) -- Mario Draghi had a good week, single-handedly stemming a plunge in inflation expectations in the euro zone.

A market-based gauge of the outlook for prices -- five-year, five-year inflation swaps -- completed its steepest weekly rise in more than seven years on Friday. The jump started after the European Central Bank president gave a speech on Tuesday flagging the likelihood that additional monetary stimulus is on the way.

Still, now he probably has to follow through with action. While up from a record-low 1.1%, the gauge is still only at about 1.3%, well short of the ECB’s medium-term inflation goal of just under 2%.

Draghi Makes His Voice Heard as Inflation Expectations Rebound

“The next 20 basis points will be much more difficult,” said Michael Leister, head of rates strategy at Commerzbank AG, which expects the ECB’s deposit rate to be cut at the next meeting in July. “Recession and trade-war fears need to ease.”

The drop in the five year, five year gauge this year had troubled most ECB officials, who saw it as a sign investors may be losing faith in their outlook. That fear was heightened when the slide accelerated after the ECB’s June 6 policy meeting, despite the central bank’s extension of its commitment to keep interest rates unchanged.

Draghi went further this week, saying the institution would act if the economy doesn’t improve -- a more dovish tone than previous language that suggested the outlook would need to deteriorate first.

Even if the ECB does follow through with a rate cut or the resumption of large-scale bond purchases, it might not be enough. Some investors fear that inflation is stuck chronically low and monetary stimulus simply risks pumping up already-pricey financial assets, potentially creating bubbles.

Draghi has explicitly blamed global trade tensions for the euro zone’s weakness, saying those need to be resolved. At a European Union summit on Thursday, where he won a standing ovation for his contribution to keeping the euro alive in an eight-year term marked by crises, he said looser fiscal policy may be needed if the outlook deteriorates further.