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14-06-2019 | Insight

ECB to pull out all the stops again?

  • Jeroen Blokland
    Portfolio Manager

Eurozone inflation expectations have fallen to a historic low. After years of quantitative easing (QE), the European Central Bank has achieved little when it comes to inflation. But it'll need to get a lot worse before we see a new round of QE.

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Back to square one

One of the most followed inflation indicators for the Eurozone, the 5-year/5-year forward inflation swap rate, has reached a new low. At 1.23%, long-term inflation expectations are even below the level of 2016, when the ECB was buying up both government and corporate bonds. In the meantime, the ECB balance sheet has expanded by some EUR 1.5 trillion, and we are basically back to square one.

Does this mean that the ECB is going to introduce a new package of stimulus measures, including even more QE? At the moment, this does not seem very likely. Of course, the ECB wants to keep all options open. In the notes to the monetary policy, president Draghi announced that for the time being, rates will not be hiked. In any case, not until at least the first six months of 2020, six months longer than previously indicated.

Draghi also stated that the central bank is prepared to deploy all available instruments, should the situation give cause to do so. Since we also saw a further dovish statements from the Federal Reserve, rates fell further.

Limited scope

And yet the scope for further stimulus measures seems limited. First and foremost, because a new round of purchases could quickly lead to scarcity, particularly of German government bonds. The ECB would have to change the rules of the game for purchases, something the bank has not been particularly keen on in the past. And the scope for lowering rates further – deposit rates are still at -0.40% – is limited as well. 

Although disputed from time to time, it's an open secret that at least some of the central bank's governors are worried about the undesirable consequences of negative rates. One example of this is how people in some countries are punished for holding savings. Another being that you can get a mortgage for nearly 0%.

Not really necessary

In addition, it is debatable whether extra measures are really necessary. The so-called super core inflation number (inflation corrected for all volatile components) has crept up further in recent years. Admittedly, at 1.35% that inflation number is not what it should be, but the trend is clearly upwards. Furthermore, although economic growth is uninspiring, the numbers are not gloomy. 

GDP growth of 1.2% is expected for 2019, with 1.4% forecast for next year, not far short of the long-term potential of the Eurozone. In short, even though inflation expectations have fallen sharply, the chance of a new round of quantitative easing currently seems small. Only if the risk of a recession increases significantly, will the ECB take bold action. 

For now, we might see a minute rate cut of 0.1%, but that'll be it. The question is of course, after the enormous interest-rate declines in recent weeks, whether bond investors will also see it that way.

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