Inflation expectations play a key role in the conduct of modern monetary policy, as central banks want to be forward-thinking and shape monetary policy by looking ahead rather than fixating on the rear-view mirror.
Inflation expectations are difficult to measure with precision, but in the main, there are two ways to estimate them: through surveys taken from various groups and by analysing the breakeven inflation rate in the bond market. It should be borne in mind, though, that the breakeven rate incorporates other factors as well, including a premium for uncertainty about real yields on non-indexed bonds, plus a liquidity premium.
In the bond market, the breakeven rate has persistently been well above the Central Bank’s (CBI) 2.5% inflation target. The long-term breakeven rate in particularly has been stubbornly high by this measure, which can be assumed to reflect market agents’ long-term inflation expectations and the factors mentioned above.
When the CBI began lowering the policy rate in October 2024, the two-year breakeven inflation rate was about 3.7% and the five-year rate was 3.8%. The five-year rate five years ahead – which should give a balanced indication of market agents’ long-term inflation expectations – was 4.1%. At the time of the CBI’s last interest rate decision, 21 May 2025, the two-year rate was 3.6%, the five-year rate 4.0%, and the five-year rate five years ahead 3.8%. By this measure, the breakeven rate had not kept pace with the 1.75 reduction in the nominal policy rate since last autumn.