FRANKFURT, March 31 (Reuters) – The European Central Bank has developed models to more closely monitor shifts in inflation expectations, it said in a blog post on Tuesday, a potentially crucial innovation as policymakers study whether surging energy prices would require rate hikes.
Inflation is rising quickly around the world as oil prices have nearly doubled since the start of the U.S. and Israeli war on Iran. The ECB has made clear it would raise rates if the energy shock gets entrenched, impacting other goods and services prices via second-round effects.
While policymakers are focusing on expectations as a potential rate hike trigger, its existing metrics all have shortcomings.
Surveys are not frequent enough or do not cover a long enough time horizon while market-based expectations also include risk premiums that are difficult to separate from actual expectations.
“We use a model to transform infrequent survey data into a dense grid of expectations,” ECB economists said in a blog post, which does not necessarily represent the bank’s views.
“This allows us to infer expectations even for points in time that were not covered by the forecasts,” the blog post said. “In other words, for every month, we fill in missing horizons and construct a smooth, monthly curve.”
The models enrich information from the ECB’s own quarterly Survey of Professional Forecasters and from the Consensus Economics survey.
Separate models are also used to subtract risk premiums from markets-based expectations and this “clean” estimate closely aligns with survey inflation expectations in the short- and medium-term horizons, the blog added.
(Reporting by Balazs Koranyi; Editing by David Gregorio)
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