ECB Update:Inflation Expectations Stuck Amid Sluggish Recovery

By Johanna Treeck

FRANKFURT (MNI) – The European Central Bank’s liquidity flush is slowly dripping through to the real economy, euro area bank lending data showed Wednesday, adding to evidence that the region continues its gradual recovery.

Yet as neither ongoing growth, nor the announcement of more easing measures flanked by rising oil prices have managed to lift inflation expectations, concerns about the Bank’s credibility have resurfaced.

The ECB, in its regular M3 conference call Wednesday, reported that the annual growth rate of loans to non-financial corporations rose to 1.1% in March from 1.0% February. The annual growth rate to loans to households steadied at 1.6%.

The release follows on the heels of the ECB’s first quarter bank lending survey, which painted an overall more optimistic picture on credit flows in the currency region.

"Credit is improving significantly, both in the volume and cost of loans, and economic activity is recovering," Executive Board member Benoit Coeure observed in an interview with Italian paper Il Sole 24 Ore released earlier Wednesday.

While Coeure underlined that the ECB’s March easing package was "very strong" and measures implemented so far had proven successful, he did recognize that one indicator continues to underwhelm: inflation expectations.

The ECB’s Survey of Professional Forecasters Friday showed that experts expect inflation to undershoot target over the entire forecast horizon, averaging just 1.6% in 2018.

The five-year, five-year breakeven forward rate Tuesday traded at around 1.4%, continuing to undershoot levels seen before the last two easing rounds. The rate was closer to 1.5% ahead of the March meeting and 1.8% ahead of the December policy announcements.

Coeure dismissed suggestions that weak inflation expectations suggest the Bank has lost credibility.

"This is not a question of trust in the ECB. We are in a unique situation in terms of inflation," Coeure asserted. "We have a combination of strong disinflationary forces, which are the legacy of the crisis and a series of negative external shocks, especially lower commodity prices, all of which explain why inflation is very low and increasing only gradually."

What Coeure might find more difficult to explain is why medium-term inflation expectations in the euro area and the US react so differently to the common driver behind low headline inflation: commodity prices.

Inflation expectations, as measured by the five-year break even rates in both the US and Europe, moved down along with oil prices, sparking concerns that investors are losing faith in central banks’ ability to delivery price stability. For the ECB, this "was the sign that it was important to act, and to act strongly, as we did," Draghi recalled last week.

Yet as inflations expectations in Europe stopped trailing oil prices just at the wrong time – when oil prices stated moving up – the US equivalent continued to move in tandem.

Draghi last week called for patience, suggesting that expectations will rise once base effects lift headline inflation in the latter part of this year. Yet until this materializes, worries about the Bank’s credibility will no doubt linger behind the ECB President’s new sanguine facade.

 

Ashley Joye Managing Partner T +44 (0)20 7422 2975 M +44 (0)7796 308 391 E ashley.joye@archr.com 49 Carnaby Street, London, W1F 9PY United Kingdom ARCHR.COM