DAYS before the European Central Bank (ECB) is expected to deploy its ultimate monetary easing weapon, financial markets are showing no sign of confidence that it will push inflation anywhere near target in the next decade.

    The ECB is expected to launch a program to print hundreds of billion of euros in new money by buying government bonds as soon as today, with the explicit aim of boosting inflation. Yet market-implied inflation expectations have fallen relentlessly.

    The major driver has been a nearly 60 percent drop in oil prices since June, hitting the cost of a wide range of goods and services and taking investors and policymakers by surprise.

    What is striking, though, is that inflation expectations in the eurozone have fallen at a similar pace to that seen elsewhere, including the United States, where the Federal Reserve is expected to tighten monetary policy this year.

    Market participants say that is because investors are beginning to doubt the power of quantitative easing as a policy tool. Some even question the ECB’s credibility.

    The euro five-year, five-year break even forward, a gauge of the market’s longer-term inflation expectations, has fallen 60 basis points in the past six months and 20 bps this year alone.

    The contract, which shows where markets expect 2025 inflation forecasts to be in 2020, trades at record lows around 1.50 percent, well below the ECB’s roughly 2 percent goal. Its U.S. equivalent stands at 2.16 percent, down from 2.33 percent in December and 2.80-2.90 percent half a year ago.

    It is expected to rise in Europe a bit once the ECB announces QE, but not by much.

    “You can forget getting break evens back to where the ECB wants them to be,” said Ralf Preusser, head of EMEA rates research at BofA Merrill Lynch. “You’ve got to price some probability that it won’t work.”

    “It is a rational market reaction to the fact that all central banks have failed to hit their inflation targets over the past four-five years. The market doesn’t believe that QE is the miracle cure. It can only be part of the solution.”

    Nor can the ECB blame the oil price fall for the expectation it will miss this target: by ignoring the first five years of the 10 year period, the measure in theory should not be correlated with commodity prices. The impact of 2014’s drop in oil prices should have long disappeared from inflation numbers by 2020, whether or not crude rebounds.

    While there are questions over whether the ECB has waited too long to deliver QE, some in the market also caution against being too critical.

    (SD-Agencies)