Comprehensive monitoring of inflation expectations

In the latest edition of its Monthly Report, the Bundesbank argues in favour of shedding light on inflation expectations using various metrics and also expanding the scope of analysis to include expectations from inflation options alongside those from surveys, inflation-indexed bonds and inflation swaps. These additional insights could prove useful, as it is essential for a monetary policy geared towards price stability to influence long-term inflation expectations in the desired manner to the best of its ability and respond appropriately to possible changes. Inflation expectations are “anchored” if, in the long term, enterprises, trade unions and financial market participants expect inflation rates that meet the definition of price stability – a clear sign that a central bank has committed to its objective in a convincing and credible manner.

Additional analysis possible

Inflation expectations are generally derived from survey data or from financial market instruments such as inflation-indexed bonds and inflation swaps. Expectations determined in this way make it possible to assess the course of future inflation developments. According to the June edition of the Monthly Report, inflation options – a relatively new type of financial market instrument – could be used to provide additional analysis on the probabilities of certain future inflation rates occurring. This could provide answers to the following questions, among others: how widely do market participants' expectations deviate from the mean? How probable is it in the minds of market participants that inflation rates will become abnormally high or low? How high is the probability of inflation rates falling below zero within a certain timeframe?

Inflation expectations occasionally vary considerably

The Bundesbank analysed inflation expectations between 2009 and 2014 based on inflation options. Bundesbank economists ascertained, inter alia, that assessments regarding future inflation developments in the euro area became increasingly divergent as the sovereign debt crisis deepened in 2012. At the height of the crisis, market participants appeared to find it difficult to assess the manner in which the monetary policy measures taken would affect the inflation rate in the euro area. Yet, as other analyses have also suggested, it cannot be inferred from this that inflation expectations were no longer firmly anchored. Furthermore, according to the Bundesbank, inflation options indicate that the probability in the eyes of market participants of expected future inflation rates falling below zero rose temporarily at the peak of the crisis, but also in the latter half of 2014.

On top of that, long-term inflation expectations have synchronised considerably in the euro area, the United States and the United Kingdom in recent times. Having plunged in all three currency areas last year, they edged slightly upwards again at the beginning of 2015. This suggests that, irrespective of the monetary policy in place in each region, long-term inflation expectations are occasionally influenced by global factors such as the oil price, write Bundesbank economists. However, they stress that it is still too early to say with any degree of certainty whether this influence will continue to have an impact over the longer term.