Market concerns over the eurozone inflation outlook can be seen by looking at the lower low registered on the 5y5y inflation swap rate.
The 5y5y rate is now below the August low that had been a focus for Draghi’s Jackson Hole speech. Remember that Draghi told us that the 5y5y inflation swap rate is the “metric that we usually use for defining medium term inflation”.
Lower demand from banks only increases the pressure on the ECB to do more via credit easing, but the fall in 5y5y inflation swaps suggests a lack of confidence. The credit easing bazooka of buying ABS, RMBS and covered bonds is not considered sufficient to allow the ECB to expand its balance sheet fast enough.
For peripheral bonds, there is likely to be a pick-up in volatility given uncertainty on the timing of when government bond purchases will be included in the existing purchases.
The need for political backing (especially from Germany) and a likely desire to see the results of the Dec TLTRO (seen more successful) will likely mean that the ECB will not be rushing to suggest that the QE door will be opened further.
Ultimately, any spread widening on peripheral bonds should be used to play for an eventual narrowing, to which government bond purchases via QE will bias 10yr Italy and Spain to trade close to 100bp.