ECB officials fear investors are losing faith in inflation goal

Bloomberg

Fears are mounting at the European Central Bank (ECB) that investors are losing faith in the inflation outlook, in a self-reinforcing spiral that could force the institution to dig deeper into its stimulus toolkit.
Staff at the euro zone’s national central banks are worried that inflation expectations are becoming “deanchored,” according to officials familiar with the matter. They cited bets on the outlook for consumer prices, which fell to the lowest on record this week despite the ECB extending its commitment to keep interest rates low and pledging to do more if needed.
That sentiment contrasts with a public denial by President Mario Draghi that expectations are falling too much. An ECB spokesman declined to comment further.
Anchoring of inflation expectations is critical for a central bank, which stands to lose credibility if investors and consumers doubt its ability to reach its goal. That can increase uncertainty and damp demand, weakening the economy further and reinforcing the downward trend.
Some policy makers were already expressing their discomfort over the inflation outlook at their April meeting, yet expectations have dropped further since then. Moreover, differing comments at the Group of 20 meeting of finance chiefs this weekend in Fukuoka, Japan, suggested a lack of consensus over how the ECB should react.
The sagging market bets suggest investors believe Draghi has few tools left in the locker to get inflation back to the goal of “below, but close to, 2 percent over the medium term.” The ECB chief said further rate cuts and a resumption of bond purchases were discussed when the Governing Council met in Vilnius, though other officials said those talks were theoretical and didn’t touch on specific scenarios.
“Five-year, five-year forwards are 1.24 percent — they hovered around 1.7 percent to 1.8 percent for most of 2017 and 2018,” said Patrick Armstrong, chief investment officer at Plurimi Wealth LLP. “That is the definition of deanchored.”
Subdued inflation has been a conundrum in the developed world since the global financial crisis, and the US Federal Reserve is reviewing its own strategy. Such concerns have been heightened by slowing international growth amid trade tensions, prompting central banks around the world to turn dovish.
Senior ECB policy makers have publicly pushed back against the idea of deanchoring, noting the wider trend and stressing that market-based measures are affected by heightened global risks. Executive Board member Benoit Coeure, responsible for market operations, downplayed concerns in a speech in March, and Draghi addressed the topic in his press conference.
“There are, based on various analysis, no threats of deanchoring inflation expectations, but certainly there is a considerable mass of distribution between zero and 1.5 percent now. By the way, this fall, this slide
in inflation expectations is not happening only in Europe; it’s also happening elsewhere, although admittedly from higher starting levels,” said ECB President Mario Draghi in Vilnius.