Expert Commentary

Deflation Anchors Aweigh

The ECB is in denial over the growing deflation threat.

Last week's European Central Bank (ECB) press conference, after its regular monetary policy meeting, provided an interesting insight into its current outlook. Having declared victory over (price) deflation last year, you might think the ECB would be concerned over the fact that inflation expectations have plummeted, as shown in the chart of the 5-year, 5-year forward inflation swap which is now trading below its previous low set in 2016.

But no, ECB President Mario Draghi appeared very relaxed about the situation. Here's what he said: "It's quite clear that the sliding of the five-year-to-five-year inflation expectations corresponds to a deterioration of the economic outlook," adding, "so this is good news in the sense that it says that expectations are responding to the economic outlook, but not de-anchoring." His argument is that the previous decline in inflation expectations occurred without a bad economic backdrop and so inflation expectations were, in his word, "de-anchored" from the 2% target that the ECB has designated. Thus, now, with the Eurozone economy slowing down, it's natural that inflation expectations decline. If this seems like ivory tower semantics (semantics being the pc version of the word BS), well it is. The idea that the ECB is not living in the real world was backed up by a quote from the head of the Lithuanian central bank who said, "Markets are very important, but we make decisions, not markets." We think he is dead wrong on that score. Central banks always follow market pricing.

This is head-in-the-sand (also pc version) stuff from the ECB. The fact is that price inflation expectations are tumbling. Whether that is due to a deteriorating economy or something else matters not two hoots. Perhaps the ECB is playing it cool because it doesn't want the world to see the panic the board members must be feeling. Markets, it seems, are losing faith in the ECB's ability to keep propping the economy up. The time is fast approaching when confidence disappears altogether.

190613 MG