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Euro Zone inflation expectations at highest

A key market gauge of euro zone inflation expectations rose to its highest level since mid-2015. This is further a sign that investor perceptions over the direction of future inflation are shifting. In the past, although relief over a slowdown in the pace of European Central Bank purchases appeared, then the Euro zone bond yields were broadly steady. And evidence that expectations for higher inflation, that are boosted by Germany’s election race and signs of supply bottlenecks in recent weeks, moved into the spotlight.

The ECB has tracked, five-year, five-year breakeven inflation forward. This is a long-term market inflation gauge. It has risen almost 15 bps since the start of September. Antoine Bouvet, senior rates strategist at ING said that the rise in breakevens and inflation is a reflection of much greater inflation risk than in recent years. He added that he doesn’t think the median long-term inflation expectation has shifted materially higher. But the range of possible outcomes is much wider than it was a couple of years ago. This is stated by citing factors such as supply chain disruptions for the increase in inflation protection.

The ECB’s Isabel Schnabel said that inflation will ease next year after the current spike but she listed risks to that scenario from supply bottlenecks to higher wages. Breakeven inflation in Germany, has also shot up, a sign for some analysts that investors expect policies under the next German government could stoke inflation. Olaf Scholz, the Social Democrat candidate, beat his conservative rival in a primetime TV debate. Most experts think a three-way coalition is the most likely outcome. But this could take several months to negotiate.

Rabobank senior rates strategist Lyn Graham-Taylor stated that there is uncertainty about the coalition outcome and that is affecting the term premium in German bonds. This is especially the inflation expectation component. There is a concern that the next government could have policies that are inflationary. Germany’s 10-year Bund yield was steady at around -0.33%. Bond issuance steps up, with ING estimating that supply could reach 30 billion euros. The European Union mandated banks to sell a new 7-year bond. This is according to a lead manager memo. And Greece said it may issue a green bond in the second half of 2022.

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