ECB will miss its inflation goal – ABN AMRO

Nick Kounis, head of financial markets research at ABN AMRO, points out that the ECB’s Survey of Professional Forecasters showed that economists further revised down their expectations for inflation two-years ahead.

“They now see inflation at 1.4% over that horizon, down from 1.5% in the last reading in Q3. Meanwhile, long-term expectations – 5 years ahead – remained stuck at 1.7%, which compares to the 1.9% definition of price stability communicated by ECB President Mario Draghi. The probability around these point estimates remained tilted to the downside in both cases. Indeed, forecasters attached a 40% probability of inflation being below 1.4% over 5-years, the highest in the survey’s history. These results are broadly in line with financial market pricing. Inflation options suggest investors attach more than a 70% probability of inflation at 0-1.5% two-years ahead, while the 5y5y inflation swap is not far off historical lows (it stood at 1.23% at time of writing). These outcomes are particularly striking, given that they come after the ECB announced a package of monetary stimulus measures at the September Governing Council meeting. Although this may reflect scepticism about the ECB’s ability to raise inflation against the background of global economic weakness, it likely also reflects that economists and investors are unimpressed by the size of the package and the divisions in the Governing Council, which could trigger scepticism about the ability of the ECB to act decisively going forward. A disanchoring of inflation expectations is a key concern for central banks, as low inflation expectations can impact wage and price setting behaviour, which would keep inflation stuck at low levels. The weakness in macro data since the September Governing Council meeting combined with deteriorating inflation expectations suggests that the ECB will step up monetary stimulus in the coming months.”