LONDON (Reuters) – Mario Draghi’s dramatic Tuesday hints of further monetary easing by the European Central Bank has stabilized collapsing euro zone inflation expectations, but the departing ECB chief will struggle to calm market fears of Japan-style economic stagnation.
Draghi shocked the markets by saying the ECB bank would ease policy again if inflation fails to accelerate. That sparked the biggest one-day fall in euro area bond yields in years as investors bet that yet another cut in its sub-zero deposit rate was in the offing, and possibly even a resumption of its 2.6 trillion euro bond-buying stimulus.
Broadside - Relentless - Fall - Investor - Inflation
His broadside arrested the relentless fall in investor inflation expectations that at its core reflects doubts about the ECB’s ability to achieve its near 2% target with a toolkit now depleted by years of monetary stimulus.
Having slid since the June 6 ECB meeting to almost half the ECB’s medium-term target, a key long-term market inflation gauge – the five-year, five-year breakeven forward rate – posted its biggest ever one-day jump after Draghi spoke on Tuesday.
Pop - High - % - Wednesday - Rate
But that 10 basis-point pop to a two-week high of 1.29% on Wednesday still leaves the rate more than half a percentage point shy of where the ECB is targeting.
“Given that inflation expectations essentially drive realized future inflation…we can see that Draghi is trying to avert the prospect of deflation,” said Justin Onuekwusi, portfolio manager at Legal & General Investment Management.
Strategists - Behavior - Gauge - Draghi - Prices
Strategists reckon the behavior of this key gauge shows both that Draghi was correct to be more aggressive about promising “whatever it takes” to avoid falling prices and that the ECB has much more work to do.
“The five-year, five-year forward inflation rising is a sign that the ECB is regaining some credibility in achieving its goals. But action will have to follow,” said Benjamin Schroeder, senior rates strategist at ING...
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