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Euro area inflation expectations show a limited increase in the medium run horizons

19.11.2021

Economics in a picture: Euro area inflation expectations show a limited increase in the medium run horizons

Inflation expectations indicators play an important role in the large information set analysed by the ECB in order to set the appropriate monetary policy stance. In the years preceding the pandemic crisis, inflation expectations in the euro area remained at relatively low levels. At the beginning of the pandemic period, the disinflationary shock caused by the contraction in aggregate demand dominated, leading to a fall in inflation expectations, particularly at short-term horizons. As the economic recovery strengthens and supply side restrictions become more prevalent, there has been a surge in both observed inflation and inflation expectations throughout 2021.

Given the evolution of inflation expectations, inflationary pressures are expected to largely dissipate over the horizon relevant for monetary policy. Indeed, the rise in inflation expectations in the euro area has been more pronounced over shorter horizons. Indicators for 4 to 5 years ahead also showed an increase, but much more contained, with greater dispersion of responses. Based on the October Survey of Professional Analysts (SPF), inflation expectations for this horizon stood at 1.9%, that is, still below the ECB's objective. Although indicators extracted from inflation-linked swaps show significant increases, this movement should mostly reflect the evolution of the inflation risk premium, i.e., the compensation demanded by market participants for the uncertainty surrounding the possible variability of inflation over the term of the contract.

 

For more details, see the article Sandra Gomes, Nikolay Iskrev and Pedro Pires Ribeiro (2021), Euro area inflation expectations during the COVID-19 pandemic, published in Banco de Portugal Economic Studies (Vol. 7 N. 4).

 

Prepared by Sandra Gomes, Nikolay Iskrev and Pedro Pires Ribeiro. The analyses, opinions and findings expressed above represent the views of the author and not necessarily those of Banco de Portugal or the Eurosystem.

 

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