Consumer prices fell by 0.2% y/y in December, while the core rate rose a tad to 0.8%. The ECB can’t wait long to announce QE in order to raise inflation expectations. The market sees this as just the beginning, and coming fixings are priced even more down. Further out, trust in the ECB is waning with the 10Y inflation trading at half the ECB’s mandate.
This is the first negative inflation print since October 2009. Now like then, energy prices are the main culprit. Energy prices (representing 11% in the HICP basket of goods and services) are now down 6.3% y/y. This almost alone explains the drop of the headline inflation rate by 0.7 percentage points since mid-2015.
Inflation is negative in Spain, Italy, Greece and Slovenia. Only in Finland and Austria are rates above 1%. We expect negative inflation rates for the Euro area through the first half of the year, at least. A lot of course depends on the future development of the oil price.
Negative inflation rate ≠ deflation. But still …
The Euro area is not in deflation as prices are not declining on a broad basis. But the risk clearly exists, and is has recently risen. In 2009, the ECB could afford to look through the 5-month period of negative inflation. Now it cannot. Our current call for the ECB is a QE announcement in early March although 22 January is clearly possible, as we have stressed before. The ECB has to find sufficient consensus within the Governing Council (also about risk-sharing), finish technical preparations and it has to decide how to deal with Greek bonds given the political vacuum in Greece. We come back with our updated ECB outlook soon.
Market pricing troublesome for the ECB
There’s at least two dimensions to the market pricing and indeed the reaction to today’s number. The first is renewed drops in implied fixings which makes sense given the continued fall in energy prices. The other dimension is further out on the core.
Here, the market ignores that the core rate actually rose, and levels are priced down from their already record-low numbers. The 10Y HICPxT swap is now markedly below 1%, i.e. at half the ECB mandate, and the 5Y rate is down another 6-7bps to now just 37bps.
Forward measures – which to an extent bypasses the immediate effects of the drops in energy prices – display roughly the same pattern. This is perhaps even more troublesome for the ECB, and the risk of expectations deteriorating has passed, they clearly have done so already. The 5y5y quote is nearing 1.5% and the 2y2y measure is below 0.6%.
Nordea