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 Download PDF More on this topic

Policy Contribution

The euro as an international currency

Is a more important international role for the euro worth pursuing? What measures would achieve this result, if it is worth pursuing?

By: Konstantinos Efstathiou and Francesco Papadia Topic: European Macroeconomics & Governance Date: December 18, 2018
Read article More on this topic

Opinion

Can virtual currencies challenge the dominant position of sovereign currencies?

Marek Dabrowski and Lukasz Janikowski analyse why private money has historically failed in competition against sovereign currencies and what it means for modern virtual currencies, such as Bitcoin.

By: Marek Dabrowski and Łukasz Janikowski Topic: European Macroeconomics & Governance Date: December 15, 2018
Read article More on this topic

Blog Post

Does the Eurogroup's reform of the ESM toolkit represent real progress?

The deal reached on euro-zone reform at the December 4th Eurogroup is not ground-breaking. However, it contains a number of incremental but potentially key technical reforms – in particular regarding the ESM toolkit. Some constitute an improvement, but there are also clear flaws that should be corrected at the Euro Summit.

By: Grégory Claeys and Antoine Mathieu Collin Topic: European Macroeconomics & Governance Date: December 13, 2018
Read article Download PDF More on this topic More by this author

Policy Contribution

Forecast errors and monetary policy normalisation in the euro area

What did we learn from the recent monetary policy normalisation experiences of Sweden, the United States and the United Kingdom? Zsolt Darvas consider the lessons and analyse the European Central Bank’s forecasting track record and possible factors that might explain the forecast errors.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 13, 2018
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: Consequences of European Central Bank forecasting errors

Bruegel senior scholar Zsolt Darvas speaks about his review of systematic errors in ECB forecasting, in another instalment of the Deep Focus podcast on 'The Sound of Economics' channel

By: The Sound of Economics Date: December 12, 2018
Read article More on this topic

Blog Post

Providing funding in resolution: Unfinished business even after Eurogroup agreement on EMU reform

The recent Eurogroup agreement on euro-area reform foresees a greater role for the European Stability Mechanism (ESM) as a backstop to the banking union. This is a welcome step forward but important issues remain. We assess the agreement on how to fund banks after resolution and the best way to organise the fiscal role in liquidity provisioning to banks. We argue that the bank resolution framework will remain incomplete and its gaps could result in important financial instabilities.

By: Maria Demertzis and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: December 7, 2018
Read article More on this topic More by this author

Blog Post

ECB’s huge forecasting errors undermine credibility of current forecasts

In the past five years ECB forecasts have proven to be systematically incorrect: core inflation remained broadly stable at 1% despite the stubbornly predicted increase, while the unemployment rate fell faster than predicted. Such forecast errors, which are also inconsistent with each other, raise serious doubts about the reliability of the ECB’s current forecast of accelerating core inflation and necessitates a reflection on the inflation aim of the ECB.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 6, 2018
Read article More on this topic

Blog Post

The international role of the euro

The authors assess whether the euro area should pursue a greater international role for the euro, as outlined by European Commission president Jean-Claude Juncker, and how it might go about doing so.

By: Konstantinos Efstathiou and Francesco Papadia Topic: European Macroeconomics & Governance Date: December 3, 2018
Read article More by this author

Blog Post

Green central banking

A few weeks ago, Silvia Merler discussed the rise of “ethical investing”. A related question emerging from the discussion is whether central banks should also “go green”. Silvia reviews the latest developments and opinions on this topic.

By: Silvia Merler Topic: Energy & Climate, Finance & Financial Regulation Date: December 3, 2018
Read article More on this topic

Opinion

What the "gilets jaunes" movement tells us about environment and climate policies

Simone Tagliapietra and Georg Zachmann write on the climate governance lesson European governments should learn from the "gilets jaunes" experience.

By: Simone Tagliapietra and Georg Zachmann Topic: Energy & Climate Date: November 30, 2018
Read article Download PDF

External Publication

European Parliament

How to provide liquidity to banks after resolution in Europe’s banking union

Banks deemed to be failing or likely to fail in the banking union are either put into insolvency/liquidation or enter a resolution scheme to protect the public interest. After resolution but before full market confidence is restored, the liquidity needs of resolved banks might exceed what can be met through regular monetary policy operations or emergency liquidity assistance. All liquidity needs that emerge must be met for resolution to be a success. In the euro area, this can only be done credibly for systemically important banks by the central bank.

By: Maria Demertzis, Inês Goncalves Raposo, Pia Hüttl and Guntram B. Wolff Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 22, 2018
Read article Download PDF

Policy Contribution

European Parliament

A monetary policy framework for the European Central Bank to deal with uncertainty

In this Policy Contribution prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the Monetary Dialogue, the authors review the emerging challenges to central banks, and propose an updated definition of price stability and an adequately refined monetary policy framework.

By: Grégory Claeys, Maria Demertzis and Jan Mazza Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 22, 2018
Load more posts