The European Central Bank tracks inflation expectations, which soared and then returned to the target.

Investing.com - The European Central Bank released a new model on Tuesday that converts infrequently polled survey data into monthly estimates of inflation expectations, showing how professional forecasters initially underestimated the surge in inflation in 2021-22, although mid-term expectations remain anchored around the 2% target.

The model was developed by ECB economists Benjamin Böninghausen, Léa Gosselin, Fabian Schupp, and Andreea Vladu, analyzing data from the ECB’s professional forecasters survey and from Consensus Economics. The statistical method estimates survey participants’ expectations for a ten-year horizon at monthly frequency, with data going back to 1999.

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The analysis shows that forecasters underestimated both the size and the persistence of the inflation surge until it reached its peak. Professional forecasters did not raise their 12-month outlook to above 2% until after Russia’s invasion of Ukraine in February 2022. At that time, inflation expectations for the next 12 months jumped from 1.6% to 2.8% in just one month.

By September 2022, just before inflation peaked, expectations for the next 12 months had risen to 4.3%. The expected return to 2% was delayed by about a year, although long-term forecasts for two years and beyond still stayed around 2%.

After inflation peaked in October 2022, forecasters expected the inflation rate for the next 12 months to be 3.6%, with expectations returning to roughly 2% in the middle of 2024 to the middle of 2025. By March 2024, short-, medium-, and long-term expectations were aligned with the ECB’s 2% target.

Latest data show that inflation expectations for the next 12 months have fallen below 2%, which may reflect lower energy inflation expectations. After reaching a low of about 1.8% at the end of 2026, overall inflation is expected to return to around 2% in 2027.

The ECB compared survey-based expectations with market-based measures, which come from inflation-linked swap rates. After adjusting for the inflation risk premium, market expectations were highly consistent with survey forecasts in the short- and medium-term during the inflation surge and the subsequent disinflation period.

The model provides policymakers with a tool to assess how shocks affect inflation expectations, which is especially important as energy price pressures related to the ongoing conflict in the Middle East reappear.

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