The Eurozone (Expected) Inflation: An Option's Eyes View

We estimate inflation risk-neutral densities (RNDs) in the Euro area since 2009. We use Euro inflation swaps and caps/floors options, and introduce a simple and parsimonious approach to jointly estimate the RNDs across horizons. This way, we obtain the implicit RND for forward measures, like the five-on-five years inflation rate, which, although it is not directly traded in the market, it is a key rate for monetary policy. Then, we discuss several indicators derived from the information content of the historical RNDs that are useful for monetary policy and compare them in the light of the ECB’s decisions and communication over the last few years. Specifically, the evolution of tails risks (associated with deflation and high inflation); the balance of inflation risks; measures of risk aversion from the ECB’s Survey of Professional Forecasters (SPF); and how forward inflation rates react to the ECB’s non-conventional monetary policies (Longer Term Refinancing Operations, LTRO, Securities Market Programme, SMP, Asset Purchase Programme, APP, and its variants and extensions).