A perceived lack of ambition in the European Central Bank’s (ECB) latest stimulus efforts left financial markets with a niggling worry on Thursday that even ECB President Mario Draghi might not be able to drag eurozone inflation back up to target.
A bare minimum 0.1 percent cut to its deposit rate and a six-month extension in its government bond purchase program tipped European shares into their biggest fall in three months and sent the euro on its biggest surge since March.
The most telling reaction was in the bond market.
German and other eurozone government bond yields made their biggest jump in months and for shorter term two-year German bonds it was the sharpest rise since March 2011.
For those thinking more broadly, the eurozone five-year, five-year breakeven forward rate — an inflation expectations gauge often cited by the ECB — fell to 1.75 percent after the meeting, having been around 1.81 percent beforehand.
It was effectively an assessment from investors that 2 percent inflation in the eurozone, the single needle in the ECB’s compass, as it often used to say, would remain off the map for the foreseeable future.
“If the economy disappoints and the potency of central banks disappoint, it would be a cocktail that the market is not ready for,” said Didier St Georges, managing director of fund manager Carmignac.
Deflation fears were compounded by the euro’s sudden leap above US$1.09 and its surge against the British pound and the Scandinavian currencies, all of which potentially make imported goods cheaper and hurts eurozone exporters.
The first reading of last month’s eurozone inflation this week had shown prices rising a barely visible 0.1 percent. A revision on Thursday of the ECB’s own forecasts to 1 percent for next year and 1.6 percent in 2017 baffled investors even more.
“Everyone was expecting Draghi to be the white knight for Europe once again and he hasn’t really shown up,” Aberdeen Asset Management investment manager Patrick O’Donnell said.
For Denmark, struggling to hold its currency peg, there was relief for its central bank, which met just after the ECB decision. The Swiss National Bank, which has deeply negative interest rates after a long battle to check intense upward pressure on the Swiss franc’s value, meets next week .
For ECB watchers, though, the question was whether Draghi and his colleagues were just holding some ammunition back in case the eurozone economy takes another turn for the worse, or whether his options were now wearing thin.
The Italian ECB head had said a range of measures had been discussed and it was prepared to go further if the need arose next year.
“Financial conditions are to start raising downside risks to the ECB projections if today’s market reaction were to continue in the next days,” UniCredit chief euro zone economist Marco Valli said.
“It is worth keeping a close eye on this, because the likelihood of additional easing would largely depend on how financial conditions evolve from here,” he added.
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