Blog Post

Inflation Surprises

While it is still too early to tell if the ECB QE programme launched on March 9 will manage to bring back inflation towards the target in the medium term, a look at market- and survey-based inflation expectations data allows us to get a sense of how inflation expectations have been evolving in the last few months.

By: , and Date: April 20, 2015 Topic: European Macroeconomics & Governance

Euro area consumer price inflation, as measured by the HICP, continues to undershoot the ECB’s target of “close to, but below 2%”, currently at -0.1% in March. While it is still too early to tell if the ECB QE programme launched on March 9 will manage to bring back inflation towards the target in the medium term, a look at market- and survey-based inflation expectations data allows us to get a sense of how inflation expectations have been evolving in the last few months.

What the Market says

The chart below plots the HICP (in green), and market-based measures of average future inflation, based on zero-coupon swaps, which show the expectations over the periods from 1 to 10 years ahead.

The first observation is that market inflation expectations have been sliding continuously from 2012 to January 2015 (see the lines from blue to bright yellow), matching the sharp and steady collapse in headline HICP inflation that took place during that period, and prompting the ECB to act further and launch sovereign QE at its 22 January 2015 Governing Council meeting.

Source: Datastream, European Central Bank, Bruegel Calculations. Note: Market based inflation expectations refer to zero-coupon swaps over a time horizon of 1 to 10 years

However, since the beginning of February we can see some positive developments at the shorter horizons of 1 to about 5 years. This is shown by the upwards shifts in the dotted-lines, from lows of below zero at 1-year forward in January this year (light orange), up to nearly 1% as of last week (red). Even though inflation in the eurozone is still expected to miss its target in the next ten years (with expectations of inflation only averaging 1.4% from now to 2025), this is nevertheless a positive development and a welcome turnaround after the dis-anchoring of inflation expectations observed in the last couple of years.

What Forecasters say

This turnaround is also visible in the ECB’s Survey of Professional Forecasters. Its latest edition published last week shows a slight rebound, with two-year ahead inflation average expectations rising from 1.2% to 1.4%, while long term expectations seem to have stabilised at 1.8%.

Source: ECB SPF (Survey of Professional forecasters); Note: “Long-term” refers to inflation expectations 5 year ahead.

Another way to look at this survey is from the perspective of the distributions of forecasts. For the 2 year ahead forecasts, the share of higher forecasts has increased substantially in the new survey compared to the one published during the first quarter of 2015. There was also a noticeable narrowing of the variance of responses, suggesting a decrease of uncertainty concerning the inflation outlook for the next two years.

Source: ECB SPF and Bruegel calculations.

Why have inflation expectations increased lately?

It is difficult to disentangle the main reasons behind the recent increase in expectations, but 3 main explanations immediately come to mind: 1) the ECB QE programme, 2) the stabilisation of oil prices, 3) some positive data releases.

The charts below depicting the evolution of daily market inflation expectations can help us identify what could be driving the recent improvements.

Source: Datastream, Bruegel Calculations. Market based inflation expectations refer to zero-coupon swap rates over a 1 to 5 years period.

Source: Datastream, Bruegel Calculations. Market based inflation expectations refer to zero-coupon swap rates over a 1 to 5 years period.

The first possible event is an interview of Mario Draghi by the German newspaper Handelsblatt (2nd January, in which he suggested that the ECB was gearing up for an asset purchase programme) – this had  the mild effects of moving expectations up by 13.4, 7.6 and 1.8 basis points.

A change in direction of developments in oil prices (Brent Crude reached its trough on 13th January) contributed 5.0, 4.5 and 2.4 bps respectively.

 

Thirdly, it’s interesting to note that market measures of inflation expectations haven’t moved much at the QE announcement date. The 1-, 2-, and 5-year swap rates increased by 2.6, 5.4 and 8.5 basis points respectively. Of course, markets had been anticipating QE for a few months and were probably already pricing in some effect on inflation of the QE programme, so the absence of a large step-shift on the day of the announcement is not totally surprising.

Leading on from this, the actual implementation of the QE program did not steer swap rates much (-7.9, -5.3, 1.6)

More significantly, the two main drivers behind the upticks in the market measures, especially at shorter horizons, seem in fact to have been the releases of two inflation measures:

On 2nd March the HICP flash estimate for February came in higher-than-expected. The day-to-day change in expectations were 49.6, 29.7 and 15.6 bps respectively, an order of magnitude larger than any of the previous events studied. This idea of a positive inflation surprise is backed up by the responses of the economists participating in the Bloomberg survey who were predicting an even lower level of inflation in February (-0.4%) than what was actually observed (-0.3%).

The second surprise came in the positive producer price inflation data published by Eurostat on 7th April – again day-to-day changes were much larger than the other events – 49.9, 30.9, 14.9 bps respectively.

Conclusion

While the ECB QE programme and the stabilisation of oil prices are certainly playing a role in shaping inflation expectations on the upside, we find that the developments between December 2014 and April 2015 in market- and survey-based measures of future inflation are still mainly concentrated in the short-term and appear to come essentially from positive surprises in inflation data releases. Unsurprisingly, the surprise in inflation led to a change in inflation expectations. Whether the surprises in inflation data were themselves driven by improvements related to QE, and in particular to the recent euro exchange rate decline, or by other factors (e.g. more downward price stickiness than anticipated), remains for future research.

 

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

Monetary policy and superstar firms

The yearly Jackson Hole gathering of central bankers has focused this year on the topic of changing market structure, the rise of superstar firms, and the implications of the way they compete for central banks.

By: Silvia Merler Topic: Global Economics & Governance Date: September 4, 2018
Read article Download PDF More on this topic

Policy Contribution

Should we care about central bank profits?

The authors investigate the ECB’s profit-making activity of the last 20 years, assessing how this was achieved and the reasons why we should care more broadly about central banks generating profits.

By: Francesco Chiacchio, Grégory Claeys and Francesco Papadia Topic: European Macroeconomics & Governance Date: August 30, 2018
Read article More on this topic

Opinion

The ECB is compromising the attractiveness of euro-area sovereign bonds

The ECB should refine its collateral framework in order to continue protecting its balance sheet without putting at risk the safe-asset status of sovereign bonds of the euro area.

By: Grégory Claeys and Inês Goncalves Raposo Topic: Finance & Financial Regulation Date: August 29, 2018
Read article More on this topic More by this author

Blog Post

Criteria for entry into the ERMII and the banking union: the precedent from Bulgaria

In its bid to join the single currency Bulgaria has made commitments on financial supervision but also wider structural reform which set a precedent for future applicants for participation in the exchange rate mechanism ERMII. Most conditions, though not all, are justified by the additional demands of the banking union. But the envisaged timeline seems ambitious, and verification will not be straightforward.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: August 29, 2018
Read article Download PDF

Policy Contribution

European Parliament

Cryptocurrencies and monetary policy

Can cryptocurrencies acquire the role of money? And what are the implications for central banks and monetary policy? Read the policy contribution to understand what challenges cryptocurrencies have to overcome to replace official currencies.

By: Grégory Claeys, Maria Demertzis and Konstantinos Efstathiou Topic: European Parliament, Finance & Financial Regulation, Testimonies Date: June 28, 2018
Read article More on this topic

Blog Post

Is the ECB collateral framework compromising the safe-asset status of euro-area sovereign bonds?

Central banks’ collateral frameworks play an important role in defining what is considered as a safe asset. However, the ECB’s framework is unsatisfactory because it is overly reliant on pro-cyclical ratings from credit rating agencies, and because the differences in haircuts between the different ECB credit quality steps are not sufficiently gradual. In this note, the authors propose how the ECB could solve these problems and improve its collateral framework to protect its balance sheet without putting at risk the safe status of sovereign bonds of the euro area.

By: Grégory Claeys and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: June 8, 2018
Read about event More on this topic

Past Event

Past Event

News from the South. Proposal to strengthen the European Monetary Union: Combining fiscal discipline with risk sharing

On 4 June Bruegel, as in previous years, will host the presentation of the Euro Yearbook, a collection of experts’ insights on the construction of the European Monetary Union through 2017.

Speakers: Cristina Cabrera, Maria Demertzis, Fernando Fernandez, Massimo Giuliodori, Javier Méndez Llera and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 4, 2018
Read article Download PDF

External Publication

The changing fortunes of central banking

What are the major challenges of central banks today? This book discusses the developing role of central banks and the policies they pursue in seeking monetary and financial stabilisation, while also giving suggestions for model strategies.

By: Philipp Hartmann, Haizhou Huang and Dirk Schoenmaker Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: May 29, 2018
Read article More on this topic More by this author

Blog Post

Are SBBS really the safe asset the euro area is looking for?

The European Commission is pushing to create a synthetic euro-area-wide safe asset in the form of sovereign bond-backed securities (SBBS). However, SBBS do not fully fulfil their original promises. If introduced on a massive scale, they might increase the supply of safe assets in good times and loosen the link between sovereigns and banks. But they will not give governments a means to maintain market access during crises, they might change incentives for governments to default, and they could pose a problem to individual bonds not included in SBBS if, in the end, they are put at a regulatory advantage vis-à-vis individual bonds.

By: Grégory Claeys Topic: Finance & Financial Regulation Date: May 28, 2018
Read article More on this topic More by this author

Blog Post

The effects of Brexit on UK growth and inflation

The full consequences of Britain’s vote to leave the European Union were never going to be immediately perceptible. As we approach the second anniversary of the UK’s Brexit referendum, we can compare the subsequent economic data for the UK and the euro area and see how it diverges from the trends established before the vote.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: May 23, 2018
Read article Download PDF

External Publication

Central banking in turbulent times

Central banks came out of the Great Recession with increased power and responsibilities. Indeed, central banks are often now seen as 'the only game in town', and a place to put innumerable problems vastly exceeding their traditional remit. These new powers do not fit well, however, with the independence of central banks, remote from the democratic control of government.

By: Francesco Papadia and Tuomas Valimaki Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: May 22, 2018
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: Post-crisis prognosis for macroeconomics

The global financial crisis prompted the field of macroeconomics to rethink its methods. In this Director's Cut of 'The Sound of Economics', Bruegel deputy director Maria Demertzis addresses the changes made and the problems still unresolved, in conversation with Nicola Viegi, South African Reserve Bank professor of monetary economics at the University of Pretoria, and Frank Smets, director general of economics at the European Central Bank.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: May 15, 2018
Load more posts