The information content of the inflation term structure

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 16 January 1998

Working Paper No. 75
By Francis J Breedon and Jagjit S Chadha

This paper examines the inflation forecasting performance of the inflation term structure (ITS) derived by the Bank from conventional and index-linked bonds. We find that the ITS: (i) gives a somewhat better measure of market expectations of inflation than the nominal yield curve alone and (ii) is at least comparable with published inflation forecasts from a number of commercial and academic institutions. But inflation forecasts from the ITS have a tendency to over predict the level of future inflation which has meant that, in the period we examine, index-linked bonds have proved, ex post, to be a cheap form of funding relative to nominal bonds. This overprediction may arise from either an inflation risk premium and/or expectational errors - we cannot be sure which on the evidence.

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