The ECB’s Inflation Battle’s Been Tough. It May Get Tougher

The ECB’s Inflation Battle’s Been Tough. It May Get Tougher
Reda Farran, CFA

4 months ago2 mins

The European Central Bank (ECB) hasn’t had it easy in its battle against inflation. And with a closely watched measure of long-term eurozone inflation expectations now at a 13-year high, it doesn’t look like it’s going to get a lot easier just yet.

The “five-year, five-year forward inflation swap” is a market-derived gauge of what investors expect average inflation to be over the five-year period that begins five years from today. The measure hit 2.67% this week, its highest level since 2010 – and that’s despite some signs that the ECB’s recent interest rate hikes have actually made progress in bringing inflation under control.

While the five-year, five-year swap rate aims to reflect long-term inflation expectations beyond the current economic cycle, in practice it often moves in line with short-term price pressures and so it’s been lifted by a recent jump in energy prices. And, sure, it can also be distorted by heightened hedging activity, especially during the reduced trading volumes of August. But the fact that it has been steadily climbing in the past six months is nonetheless a potential headache for the ECB, which would find itself in a tough spot if investors are continuing to bet on long-term inflation staying well above its 2% target.

But the thing that really stands out for me when I look at this gauge is how starkly different it is from its recent history. Eurozone inflation was persistently below the ECB’s target in the decade after the 2008-09 financial crisis, and that fueled predictions of a Japan-style deflationary slump. But those predictions are now a thing of the past: wealth management firm Lombard Odier, for example, estimates that the bloc’s inflation could remain on average 1.5 percentage points higher in the decade leading up to 2032 compared to the one before, as rising prices on food and energy (made worse by Russia’s invasion of Ukraine) lead to higher and higher wage demands.



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