📝The Euro Area 1-Year Forward Inflation Curve Stabilizes Close to 2.5%: Nordea

The 5-year inflation swap rate 5 years forward is trading at around 2.5%. This measure includes a component of inflation risk premium, so levels somewhat above 2% would still be in line with the central bank’s 2% inflation target. Further, the ECB is arguing that most of the increase is due to the rise in the risk premium component rather than the inflation expectation component. Nevertheless, the ECB is following market-implied inflation expectations very closely and the hawks find plenty of support for rate hikes in the recent development. If one takes a closer look at the inflation path the market is pricing in, the picture is quite clear: inflation will fall significantly from the more than 6% priced for the next year to less than 3% between one and two years. However, the 1-year forward inflation curve stabilises at close to 2.5%, above the ECB’s 2% inflation target and miles above the pre-Covid levels. The market is thus pricing in clearly higher inflation than the ECB’s own forecasts, which still see inflation a tad below 2% in 2024. - Nordea Research