The apparent de-anchoring of market-based inflation expectations has started to rattle the ECB and has raised the spectre of a return to monetary easing, mirroring the abrupt shift in marketimplied policy rate expectations in the US where 65 bps of cuts are now pencilled in by year-end (although we believe the Fed will under-deliver). The OIS-implied probability of a 10bps cut to the ECB’s deposit rate by the December Governing Council meeting has surged to around 60%, having been seen as a zero-probability event as late as March.

Even if the ECB were to introduce a tiered deposit-rate system in order to push the deposit rate further into negative territory, the extreme shift in dovish sentiment suggests that market is looking beyond policy rate cuts and is instead gearing up for a return of QE. Indeed, with the Eonia 1y rate 5y forward rate trading at just 0.13% and implying minimal policy tightening over the medium term, and market-based inflation expectations pointing to inflation of 1% or less over the medium-to-longer-term, pressure will be on the ECB to resume large-scale asset purchases. However, this may end up being unnecessary as our leading indicators foresee growth in the eurozone picking up again over the next 6-12 months (last chart).

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Source: Bloomberg, Macrobond, Variant Perception