ECB research warns household inflation fears risk undermining price stability goals

The latest ECB Working Paper, authored by economists at the European Central Bank in collaboration with the Banque de France and the Centre for Economic Policy Research, provides a sweeping investigation into the state of inflation expectations across the euro area. The study finds that while financial markets and professional forecasters continue to trust the ECB’s two percent target, households and small firms remain far less persuaded. This split, the authors argue, represents one of the most significant challenges facing the central bank as it battles lingering price pressures triggered first by the pandemic and later by the energy shock unleashed by Russia’s invasion of Ukraine.

Expectations in Flux After a Series of Crises

For much of the euro’s early history, inflation expectations were remarkably stable. Households, markets, and professional analysts are all broadly aligned with the ECB’s policy stance. That stability began to erode during the COVID-19 crisis and deteriorated further when energy costs skyrocketed in 2021 and 2022. According to the surveys cited in the paper, professional forecasters and financial markets responded in relatively measured ways. For example, they raised their expectations during the crisis but quickly revised them downward as monetary tightening began in mid-2022. Households, by contrast, extrapolated heavily from personal experiences, particularly rising grocery and fuel bills, and adjusted their expectations much less rapidly. This led to a sustained gap, with households consistently anticipating inflation above three percent even as market indicators drifted back toward target.

Energy Prices and Wages Drive New Sensitivities

The empirical analysis reveals how strongly expectations have become tied to energy shocks since 2021. In the past, fluctuations in oil or gas prices did not have a lasting effect on household expectations. But the severity and visibility of recent surges, especially as they hit household budgets directly, made them central to the public’s inflation outlook. The report also shows that wage growth has become increasingly correlated with inflation expectations, raising concerns about the risk of wage–price spirals. The danger, researchers note, is not simply theoretical: surveys suggest that workers are entering wage negotiations with inflation perceptions well above those of markets or professional analysts. Regional differences also emerge. Peripheral eurozone economies, often marked by weaker institutional trust, display more fragile anchoring than core members such as Germany or France, underscoring the uneven playing field for monetary policy transmission.

Markets Reassured, Citizens Still Skeptical

Market-based measures such as inflation-linked swaps reflected deep uncertainty in 2022 and early 2023, soaring above two percent before moderating as the ECB raised rates. By late 2023, these indicators had largely re-centered around the ECB’s target, signaling that investors and professional forecasters still trusted the central bank’s resolve. But households told a very different story. Surveys repeatedly captured expectations around three percent or more, highlighting a credibility gap between financial actors and the general public. The charts and tables presented in the report underscore this divergence vividly: while the ten-year inflation compensation measure stabilized, household surveys remained stubbornly elevated. This two-track reality leaves the ECB in a paradoxical position; its credibility is intact among those who move financial markets, but shakier among the citizens whose behavior ultimately drives inflation outcomes.

Communication, Credibility, and the Road Ahead

A recurring theme in the report is the pivotal role of communication. The authors argue that the ECB has mastered the art of speaking to markets, but less so to ordinary households and firms. Press conferences laden with technical detail reassure investors but do little to convince people who measure inflation in the price of bread or heating bills. Unless this communication gap is narrowed, the risk remains that households will continue to expect higher inflation, feeding into wage demands and ultimately prolonging inflation itself. To counter this, the paper recommends clearer, simpler messaging that explains in plain terms how monetary policy works and why inflation is expected to return to target.

The study also urges policymakers to monitor expectations more closely at the granular level, distinguishing between countries, income groups, and firm sizes. Consistency between words and actions is highlighted as essential: only by aligning its communication with decisive policy measures can the ECB rebuild trust across all segments of society. Finally, the authors emphasize that monetary policy cannot work alone. Fiscal measures, particularly those cushioning the most vulnerable households from food and energy shocks, are vital in preventing distorted inflation perceptions from becoming entrenched.

A Battle of Numbers and Minds

The broader message of the paper is sober but not despairing. The ECB remains a credible institution in the eyes of markets, yet the real challenge lies with public perception. If households cease to believe in the two percent target, inflation expectations may become self-fulfilling and far harder to control. The authors stress that in an era of overlapping crises, from pandemics to geopolitical tensions to climate risks, anchoring inflation expectations cannot be taken for granted. The ECB, they conclude, faces a dual battle: to keep inflation under control through policy, and to convince households and firms that its target remains a trustworthy promise rather than a distant aspiration. Success in both arenas is what will ultimately determine whether the euro area can return to lasting price stability.