Investors pile into eurozone inflation bonds

Investors are pouring money into exchange traded funds tracking inflation-linked eurozone bonds at the quickest pace in five years, highlighting a dramatic shift in inflation expectations driven by the launch of quantitative easing.

The anticipated launch of QE by the European Central Bank last month spurred €400m into inflation bond ETFs during the first quarter, the largest inflow since the third quarter of 2010 when eurozone inflation was rising, according to Markit.

Attention will remain intently focused on inflation figures to gauge both the success of QE as well as its likely duration.

"The big point of inflection is the QE announcement," said Simon Colvin, vice-president of Markit. "It shows that people are taking more notice of inflation and they're looking to protect themselves from it."

Since QE was announced, the break-even inflation rate priced into five-year German Bunds has jumped more than fivefold to an eight-month high of 1 per cent, up from less than 0.2 per cent before the announcement.

"There's the question of whether the ETF flow is driven by the surge in inflation or further expectations of the working of QE - there's the short term trading gain to be made from the jump in bond prices," said Mr Colvin.

Cameron Brandt, an analyst at EPFR said the inflows are "less a vote of faith in the broad strategy than it is a belief that if QE does work it could almost work too well''.

Inflation has stubbornly remained below the ECB's 2 per cent target for more than two years and consumer prices have continued falling as demand remains low and energy costs fallen sharply.

Consumer prices in the euro area fell 0.1 per cent in March from a year earlier, but that marked an improvement from earlier in the year, when prices fell 0.6 per cent in January and 0.3 per cent in February.

In one area of the bond market, investors are looking for a turn higher in consumer prices.

Last week, the German government sold €3bn of 10-year inflation-linked bonds at a negative yield of 1.09 per cent, even deeper than the yield of minus 0.89 per cent at the last auction in March, illustrating investors' appetite for bonds that will gain in value should inflation rise over the next decade.

While QE is fuelling demand for inflation-linked bonds, rising inflation could serve to hasten the end of QE, according to Didier Saint-Georges, managing director at Carmignac Gestion.

"It's one of those periods of very suspect comfort. I think people are complacent to believe that because [Mario] Draghi said so, he will buy 60bn until 2016, I think that's a mistake - if inflation picks up," he said.

"When that risk [of deflation] gets pushed back Germany will certainly remind Mr Draghi that the only justification for QE was inflation," he added.

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