EUR: Euro Area Deflation Supports QE As We Wait For ECJ's Ruling

Euro area inflation entered negative territory in December, owing mainly to a further sharp decline in oil prices, in combination with another round of disappointing euro area data, notes Barclays Capital.

"This has put further downward pressure on medium-term inflation expectations, with EUR 5y5y breakevens reaching new multi-year lows (below 1.6%). Such a grim inflation and economic outlook further supports our view regarding the announcement of outright European Government Bond purchases by the ECB, in its 22 January meeting," Barclays adds.

This week, however, market attention will undoubtedly be drawn to the ECJ’s Advocate General, who is expected to issue his preliminary opinion on OMT legality with regards to the unlimited nature of its size and the pari passu status of the ECB on its sovereign bond purchases under OMT (Wednesday).

"We do not think that these legal proceedings will unduly delay EGB QE, though a ruling in favor of the ECB being senior in its sovereign purchases could undermine the effectiveness of QE and pose some short-term risks to our EUR bearish view. We think the ECB might avoid certain language (such as “unlimited” interventions) and may wait until the political situation in Greece cools down, before purchasing any GGBs. Nonetheless, the ECB is expected to engage in outright purchases to combat declining inflation and inflation expectations, in our view," Barclays projects.

"We continue to see significant EUR depreciation from here, particularly against the USD. On the data front, attention will stay focused on the inflation side. We expect final euro area headline and core inflation (Friday) to be confirmed at -0.2% y/y and 0.8% y/y, respectively, and look for euro area industrial production (Wednesday) to be flat in November, after only a minor rise in October. This would add to the bleak momentum in the latest PMI surveys, keeping the EUR under pressure," Barclays adds.

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