A Composite Index of Inflation Tendencies in the Euro Area

Abstract

Assessing underlying inflation developments is crucial for a correct calibration of the monetary policy stance. To monitor the adjustment in the path of euro area inflation towards the ECB’s definition of price stability, we select a number of indicators of price dynamics in the area. We then construct a composite index summarizing the information contained in those indicators by estimating several univariate probability models. The index, which provides a synthetic measure of inflationary pressures net of the most volatile components, can be interpreted as gauging the probability of inflation returning to 1.9 per cent or over within a given time horizon. Our findings, which are based on the information available in July 2017, signal that, despite the improvement in price dynamics since the beginning of the year, the adjustment of inflation rates towards levels below, but close to, 2 per cent over the medium term is still limited and far from being sustained.