Europe's Weakening Inflation Outlook Spurs Calls for ECB Action

  • Mizuho sees ECB increasing pace of asset purchases in March
  • RBS predicts 0.4 percentage-point cut to deposit rate in 2016

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

The five-year, five-year forward inflation swap rate-- which measures the price-growth outlook for a half-decade starting 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.

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 percent 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 percent 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 three basis points, or 0.03 percentage point, to 0.51 percent as of 4:34 p.m. London time. The 1 percent security rose 0.25, or 2.50 euros per 1,000-euro ($1,081) face amount, to 104.6.

Europe’s inflation outlook has been tumbling since the central bank’s latest policy meeting in December amid concern turmoil in Chinese markets will send disinflationary forces to other parts of the world. The region’s bonds have gained for most of the start of this year, though a relatively busy issuance schedule this week has seen some of the advance pare back.

Chatwell’s Call

“The ECB needs to do more and this should keep the euro-area rates markets bullish in the near term,” Mizuho’s Chatwell said. In the long-term, the yield curve will bull-flatten, with longer-dated bonds gaining faster than those with shorter maturities, he added.

German 10-year bund yields will drop to 0.16 percent this year, potentially within the next six months, said Marco Brancolini, a London-based analyst at RBS. Italian 10-year yields will fall to 0.75 percent.

Barclays Plc lowered its forecasts for euro-area inflation over the next two years. The bank sees the rate averaging 0.1 percent this year, from a previous forecast of 0.5 percent, analyst Fabio Fois wrote in client note.

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