Euro Area Inflation Expectations

Abstract

This study explores the recent dynamics of inflation expectations for the main euro area countries. It uses daily financial data for the main euro area countries over the past 15 years with a wide range of time horizons. The estimation of a model of the term structure of inflation expectations using these data allows the common part to be separated from the countryspecific part. It is found that, for the various time horizons and countries, the bulk of expected inflation is common to the whole euro area. The weight of country-specific factors is low, being most significant for the shorter term. For time horizons between five and ten years, the estimated inflation expectations showed a downward trend from 2012, which has reversed in the last two years owing to the application of a broad set of unconventional monetary policy measures in the euro area since mid-2014. Still, in the past year, medium-term inflation expectations have held below 2%, around 1.7% on average, clearly lower than in the period before the economic crisis.In contrast to these limitations, the financial markets provide abundant daily real-time information on inflation expectations. First, there are indexed sovereign bonds which provide protection against future inflation. In the euro area, although these bonds are issued by national authorities, most are indexed to the inflation of the euro area as a whole and thus do not provide information on the expected inflation in each country. Moreover, they are scantly comparable across countries owing to their different liquidities and risk levels. Second, traded daily on the markets are inflation swaps linked to the inflation of the euro area and of its main countries (France, Italy, Spain and Germany), with 15 maturities ranging from 1 to 30 years, which contain information on the expected future course of

Systemic analysis framework for the impact of economic and financial risks

“…Among these models, first there are those aimed at analysing inflation expectations and the probabilities of monetary policy movements based on bond and inflation derivatives market prices (futures, options, forwards and swaps). Here we mainly follow the models of Gimeno and Ibañez (2018), Gimeno and Ortega (2018) and Aguilar and Gimeno (2022).…”