Inflation expectations
Inflation expectations are forward-looking beliefs about future price changes; when expectations become unanchored from a central bank's target, they can become self-fulfilling.
What they are
Inflation expectations are beliefs — held by firms, workers, investors, and consumers — about how much prices will rise over the next one, five, or ten years. These beliefs are not merely academic: they feed directly into today's economic decisions. A worker who expects 4% inflation will demand a 4% pay rise; a firm that expects input costs to keep rising will front-load price increases; a bond investor who expects higher inflation will demand higher yields.
This self-fulfilling character is why central banks treat expectations as the most important variable to anchor. The Fed's framework and the ECB's strategy review both identify anchored expectations as the primary mechanism through which inflation targets work.
How expectations are measured
Three main approaches exist:
Consumer surveys: The University of Michigan Consumer Sentiment Survey asks households about their 1-year and 5–10-year inflation expectations. The ECB runs an equivalent. Survey measures are "noisy" (influenced by recent petrol prices) but capture actual household psychology.
Market-based breakevens: The spread between nominal Treasury yields and TIPS (inflation-linked bonds) gives an implied inflation expectation. The 5-year/5-year forward breakeven is the Fed's favourite market measure — it strips out near-term cyclical noise.
Professional forecaster surveys: The Fed's Survey of Professional Forecasters (SPF) and ECB's SPF ask economists for 1-year and longer-term inflation predictions. These are the most closely monitored by central banks.
Anchored vs unanchored expectations
When long-run expectations remain near the central bank's inflation target even during periods of high inflation, they are "well-anchored" — markets and households trust the bank will bring inflation back. This is what allows central banks to "look through" supply shocks without immediate aggressive hikes.
Expectations become "unanchored" when long-run measures drift persistently above or below target — a sign that credibility is eroding. The cost-push shocks of 2021–22 tested anchoring globally; the Fed's neutral rate debate partly reflects uncertainty about where expectations have resettled. Our guide to understanding inflation expectations walks through the practical implications.