Central banks seemingly toothless in the face of weak inflation

Edito Breakeven inflation rates for European linkers recovered in July. After breaking below 0.70% at the start of last month, breakeven for the 10-year Bund€i went on to recover and met 0.96% by the end of the same month. The rebound of the 10-year Bund€i is surprising in that it is timed when yields for its nominal counterparts are tending to ease, the yield for the 10-year Bund sitting at below -0.50%. In theory, breakevens are directional, declining when interest rates decline. Crude oil prices fail to explain this atypical behaviour, as Brent was just about stable over the month. Finally, with European inflation remaining way below the official target, this also fails to explain the recovery in European breakeven inflation rates. In fact, the explanation making the most sense is that breakevens fell too low: there are not many compelling reasons why European inflation should reach 0.7% on average over the next decade (unless you subscribe to the view that the Eurozone, like Japan, is in the throes of deflation). Our view is that, over the medium term, the 10y bund€I B/E will remain below 1%. In the United Kingdom, Boris Johnson ’s victory has increased the risk of a no-deal Brexit and stoked inflation expectations, as a result of which breakeven for the 10-year index-linked Gilt has recovered to around 3.40%. It is the risk that sterling will plummet further that is boosting British linkers (see left-hand chart).