(Bloomberg) -- Investors are betting the European Central Bank will fall short of its inflation goal in coming years, entrenching lower yields in the region.
Expectations for euro-area inflation in the swap market is holding near the lowest in two years, ahead of a consumer-price readout Wednesday. That’s giving fuel to traders buying bonds amid signs policy makers haven’t agreed a course of action to back up ECB President Mario Draghi’s recent dovish rhetoric.
European bond yields have fallen to multi-year lows as talk of “Japanification”, where inflation and volatility remain permanently low, peppers analyst notes. Draghi acknowledged last week that the economic weakness could extend into the rest of the year, following a dovish tilt from the bank earlier in the year that upended market bets on an interest-rate hike anytime soon.
“The ultimate result will be lower rates and lower rates vol,” said Joubeen Hurren, a money manager at Aviva (LON:AV) Investors, who has a long position in inflation-linked Treasuries.
Euro-area annual inflation is expected to come in at 1.4 percent for March, slower than 1.5 percent the previous month, according to a Bloomberg survey of economists. Five-year, five-year inflation swaps, the ECB’s preferred gauge of inflation, touched 1.24 percent in March, the lowest in over two years.
Speculation has mounted that the ECB could add stimulus by tiering its deposit rate to ease pressure on banking profit margins, but officials lack enthusiasm for any revamp of the negative rate policy, according to people with knowledge of the matter.
In the absence of that, markets are likely to focus on a new wave of cheap loans for banks, known as targeted longer-term refinancing operations, which could be announced in June. Until then they will watch for any signs in European data that an economic recovery in China is filtering through into the global economy.
For Pacific Investment Management Co., sliding inflation raises questions over whether the ECB has the will or the instruments left to combat it. The bank could enter “the next recession without ever having normalized its policy stance,” said Pimco money managers Andrew Bosomworth and Konstantin Veit.