MONETARY POLICY REPORT | AUTUMN 2021 (box 1)
(authors: Soňa Benecká, Filip Novotný, Michaela Ryšavá)
Inflation expectations provide information about how economic agents view future inflation. They simultaneously have a significant effect on actual inflation. Firms change their prices based on their expectations. In collective bargaining, growth in wages and salaries adjusts to the expectations of firms and trade unions. This in turn is reflected in costs and, coupled with households’ inflation expectations, in prices of goods and services. Expectations of higher prices thus often become a self-fulfilling prophecy. The anchoring of inflation expectations at the central bank’s target is meanwhile an important measure of the success of its monetary policy. This box examines how inflation expectations in the euro area are formed against the background of the current rapid price growth and the so far tentative approach of the ECB.
The euro area has been experiencing a sharp rise in inflation since the start of this year. Observed consumer price inflation has been strongly affected by the coronavirus pandemic. The behaviour of households has changed and the share of goods in consumption has risen at the expense of services hit by government shutdowns. Demand has been supported by an easing of ECB monetary policy in the form of the Pandemic Emergency Purchase Programme (PEPP) and by strong government fiscal stimuli (especially in Germany).[1] The usual pattern of inflation has also been disrupted by an absence of seasonal sales. Moreover, growth in headline inflation has been supported by a surge in energy prices since March 2021. Euro area inflation rose further in September as energy price inflation went up considerably on the eve of the heating season. The ECB has so far adopted a wait-and-see response to the elevated inflation, regarding it as being driven mainly by one-off and temporary factors.[2] Despite a slight retreat from the asset purchase programme in September, the ECB’s monetary policy stance remains highly accommodative, owing mainly to interest rates, the outlook for which has long remained close to zero.
Short-term inflation expectations in the euro area are increasing due to the current high inflation. The European Commission survey (see Chart 1) indicates that an increasing share of European households expect inflation to be the same or higher than now in one year’s time. Short-term inflation expectations are affected mainly by current changes in prices of the most frequently purchased goods, which include energy and processed food.
Chart 1 – Owing to the current sharp rise in prices, consumers are expecting higher inflation one year ahead in all euro area countries
households’ expectations regarding inflation in next 12 months; balance of answers; seasonally adjusted; source European Commission Business and Consumer Survey
Among the selected countries, Germany and Slovakia have the highest shares of consumers with elevated inflation expectations, but a sharp jump in inflation expectations has also recently occurred in Spain and Italy. The European Commission survey shows that the growth in prices has also hit retail trade in Germany and to a lesser extent in Slovakia and Spain. The share of firms expecting prices to go up is also rising, especially in industry and construction. By contrast, no marked price growth in services is expected in Italy and France.
An alternative view based on the expectations of the Consensus Forecasts analysts (see Chart 2) points to a rise in inflation expectations next year in only some euro area countries. According to their outlooks for 2022, unanchoring from the target is mainly visible in the Baltic States and Slovakia, i.e. in converging euro area member states, where current inflation has markedly overshot the inflation target. In Germany, inflation expectations for next year are now just above the 2% target. We can see relatively stable inflation expectations in Spain, Austria, France and Greece. By comparison with other major world economies, such as the USA and the UK, the analysts’ expectations for the euro area are more stable with respect to the central bank’s target.
Chart 2 – Analysts’ inflation expectations for next year have risen above the inflation target in only some euro area countries
%; source Consensus Forecasts
Note: The average of the historical inflation expectations for 2022 is calculated for the period 1/2018–9/2021. Current inflation expectations for 2022 are from October 2021.
Long-term inflation expectations in the euro area are well anchored. Over the past 16 years, the regular survey of the Consensus Forecasts analysts has shown good anchoring of expected inflation five or more years ahead (see Chart 3).[3] The recent change in the definition of the ECB’s inflation target has changed nothing about that. Financial market expectations as represented by five-year inflation-linked swaps are more volatile. Despite having risen recently, however, they are still well below the ECB’s inflation target and lower than before 2015.
Chart 3 – Long-term inflation expectations in the euro area remain well anchored
%; five-year inflation-linked swaps and outlooks of CF analysts regarding inflation 6–10 years ahead; source Bloomberg and Consensus Forecasts
Inflation expected in the long term is higher in the USA than in the euro area. This has also often been the case in the more distant past. It may be due to multiple factors, among other things the Fed explicitly adopting the 2% inflation target as late as 2012 and its mandate not being focused solely on price stability. However, the analysts’ recent expectations for the USA may point to an alternative view of the currently elevated global inflation pressures.
The current surge in inflation in advanced countries – caused largely by the negative supply impacts of the coronavirus pandemic and by economic policy demand stimuli – has been reflected in an increase in short-term inflation expectations in the euro area. However, long-term inflation expectations remain well anchored so far.
[1] Moreover, prices in Germany recorded a sharp jump in January 2021 as VAT rates returned to their original levels following a temporary decrease (the tax was lowered between July and December 2020 to support pandemic-hit households) and taxation of carbon dioxide emissions increased.
[2] However, the account of the latest monetary policy meeting suggests that two camps are emerging in the ECB, as voices calling for a more pronounced reduction in asset purchases are gaining strength.
[3] However, we should bear in mind that analysts generally stick to their outlooks for a long time before a real impulse to change them occurs. This inertia is intensified by the general rule that it is better to be wrong with the crowd than to leave the consensus and risk being the only one to contribute an erroneous outlook.