Investors remain unimpressed by the efforts of the European Central Bank to boost inflation in the euro zone. While that may strengthen the hand of those who want the ECB to embark on all-out government bond purchases, even such desperate measures may flop.
Growing doubts about whether monetary policy can lift near-zero euro zone inflation is reflected in the ECB’s preferred yardstick of inflation expectation. It tracks how investors see prices behaving over a five-year period, starting five years from now. This “five-year, five-year forward” rate briefly rebounded in August after Draghi flagged a full-blown effort to ease monetary policy further. But it didn’t last long, and the measure has tested record lows at 1.91 percent this week. This is even though September saw the ECB cut rates, outline plans to buy asset-backed securities and covered bonds, and launch the long-term loan scheme for banks it had unveiled a few months ago.
Granted, investors’ expectations may be too gloomy. Demand for the first round of ECB loans was disappointing last week, but there will be another batch on offer in December, which could attract more interest. Also, the euro’s fall will help lift inflation. A rough rule of thumb is that a 10 percent drop in its trade-weighted value ends up boosting inflation by 0.4-0.5 percentage points. The euro has declined 4.6 percent since March, and will fall further.
But the longer inflation stays low, and the further inflation expectations fall, the harder it will become for the ECB to avoid more radical remedies. Draghi said in a speech in April that a worsening of the medium-term inflation outlook would warrant a more broad-based asset-purchase programme. He also said this week that the central bank can deploy additional unconventional measures if needed.
Still, government bond-buying may not be the answer. Declines in sovereign borrowing costs are supposed to filter through the economy, but can’t help if households feel too insecure and impoverished to borrow. U.S. and British quantitative easing did not have the explicit aim of pushing up inflation, and, if experience is any guide, such bond-buying is no guarantee of hitting inflation targets.
No wonder Draghi keeps urging government to do their part.