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Draghi is Winning Main QE Battle

Huge bond market turbulence is driving up euro zone yields. But Mario Draghi's magic is working, despite appearances to the contrary. The quantitative easing programme which the president of the European Central Bank shepherded into existence is meeting one of his main objectives.

Were euro-QE aimed at lowering yields on sovereign debt, then Draghi would be wondering what had gone wrong. The yield on the German 10-year government bond, the euro zone’s benchmark, was 0.4 percent and falling just before the purchase programme started in March. As of May 11, it was 0.65 percent, 13 times the record low set in April.

Draghi is presumably pleased by tentative signs that the credit market is improving but the main goal of QE was not to push already-low yields still lower. In the euro zone, the principle purpose of QE was to eradicate the deflationary psychology which risked taking root.

On that, Draghi is getting his way. In August 2014, he explicitly highlighted one yardstick of inflation expectations, the so-called five-year/five-year forward rate, which was falling. This is a measure of how investors expect inflation to behave in the five-year period which starts five years from now. This gauge has risen to 1.82 percent from less than 1.5 percent in mid-January, though it is still about 15 basis points short of even those August levels.

It's not just the markets which see more inflation coming. A European Commission survey in April showed retail and industrial companies expect prices to keep rising while the Economic Cycle Research Institute’s gauge of the euro zone inflation outlook, which incorporates government, market and survey data, rose to its highest in three and a half years in March.

The shift in inflation expectations is not entirely due to the ECB's words and actions. The fall of the oil price in 2014 was deeply disinflationary. Crude prices have rebounded by more than a third since January. But the ECB deserves a bit of credit. So far this year, euro zone five-year/five-year forwards have risen by more than a comparable measure for the United States.

This will give Draghi far more satisfaction than record low German government bond yields ever could.

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