A key measure of long-term eurozone inflation expectations fell below the European Central Bank’s (ECB) 2% target for the first time since July 2022, signaling that faltering economic growth may lead to lower inflation in the years ahead.
The five-year, five-year forward inflation swap—a metric reflecting expectations for inflation five years from now—dipped to 1.9994% on Tuesday, down sharply from above 2.2% in October, according to LSEG data. This decline comes as investors increasingly bet that weaker growth in the eurozone will suppress inflation.
Implications for the ECB
Inflation expectations are closely monitored by central banks as they influence spending and saving behaviors. Former ECB President Mario Draghi highlighted the five-year, five-year swap as a critical indicator in 2014 when it previously hovered below 2%, emphasizing its role in shaping monetary policy decisions.
Eurozone inflation has already eased significantly, dropping from a record high of 10.6% in October 2022 to 1.7% in September this year before ticking back up to 2% in October. Analysts attribute the decline to improved supply chains post-COVID, lower energy prices following the Ukraine war, and tighter monetary policy. November inflation data is set for release on Friday.
Economic Weakness and Policy Response
Recent survey data revealed a sharper-than-expected contraction in eurozone business activity in November, raising fears about stagnant growth. The ECB’s Chief Economist Philip Lane warned on Monday that prolonged restrictive monetary policy could exacerbate the slowdown and push inflation below target.
“Monetary policy should not remain restrictive for too long,” Lane told Les Echos. “Otherwise, the economy will not grow sufficiently, and inflation will, I believe, fall below the target.”
The ECB faces a delicate balancing act as it weighs the risk of deflation against the need to support economic activity in the bloc.