Inflation Expectations

Expectations about inflation matter because they influence behaviour today. If workers expect prices to rise by 5% next year, they are likely to ask for wage increases of at least that much. If businesses expect their costs to rise, they may raise prices in advance. In this way, expectations of high inflation can help create high inflation.

Central banks pay close attention to inflation expectations. When expectations are anchored, meaning people trust that inflation will return to the central bank's target over time, temporary price shocks are less likely to turn into persistent inflation.

Inflation expectations are measured in several ways. Surveys ask households, businesses and professional forecasters what they expect. Financial markets also provide estimates, for example by comparing yields on ordinary government bonds with yields on inflation-linked bonds.

For example, if a ten-year government bond yields 4% and a ten-year inflation-linked bond yields 1.5%, the difference of 2.5 percentage points suggests investors expect inflation to average roughly 2.5% a year over the next decade.