Gauging ECB Concerns: Analysing the Impact of COVID-19 on Inflation Through the ECB Fear Inflation Index.
The article uses the ECB Fear Inflation Index as a tool to examine the impact of the COVID-19 outbreak on Euro Area. The index shows rising inflation fears during the pandemic, a decline in mid-2022, and a resurgence in early 2023, reflecting the varying ECB's inflation concerns.
Reading time: 4 mins.
The COVID-19 pandemic had a significant impact on economic activity and inflation within the euro-area. Initially, the pandemic caused severe disruptions across various sectors resulting in a sharp contraction in economic activity. As restrictions were implemented to prevent the spread of the virus, consumer spending plummeted, and supply chains were heavily disrupted.
However, as lockdown restrictions started easing and economies began to reopen, there was a swift rebound in demand. This sudden surge in demand, coupled with ongoing supply-side challenges, created a perfect storm for inflationary pressures.
In this short article, we examine the Advance Macro ECB Fear Inflation Index and how it can be used to gauge ECB uncertainty over ongoing and upcoming inflation developments.
Introducing the Advance Macro Fear Inflation Index.
The ECB Fear Inflation Index is constructed from central bank press-conferences material and it can be defined as an index summarising the amount of "fear" or "concern" about inflation as inferred from non-verbal communication cues during these events. This index offers a unique perspective on the central bank's sentiment towards inflation beyond the content of verbal statements.
The ECB Fear Inflation Index is constructed separately for the introductory statement and Q&A sessions, acknowledging the intrinsic differences in how these modalities are conducted. In particular, introductory statement sessions are more controlled, with officials reading from scripts, which might limit the expression of spontaneous non-verbal cues. On the other hand, Q&A sessions are less scripted and as such tend to evoke more spontaneous reactions and a broader range of non-verbal communications, as officials respond to potentially challenging or unexpected questions.
Furthermore, to reflect the amount of coverage that inflation and related topics attract during a press conference the scores are also weighted by attention scores. These are representing the amount of mins (as % of the total) spent covering inflation and related topics. This weighted approach ensures that the index not only captures the level of concern evident in non-verbal cues but also considers the emphasis on inflation-related discussions in the overall context of the conference.
The ECB Inflation Fear Index as a barometer of inflationary concerns.
We proceed to plot the unweighted and weighted ECB Fear Inflation scores against the year-on-year % change in the Euro Area HICP Inflation (Overall) , see Figure 1 and Figure 2 below respectively. We also plot the unweighted and weighted scores against the year-on-year % change in the Euro Area HICP Core Inflation, see Figure 3 and Figure 4 below.
It is evident from Figure 1 - Figure 4 above, that as the covid-19 outbreak unfolded the Fear Inflation Index started steadily rising amid concerns of inflationary pressures. Both the Statement and Q&A scores reflected ongoing inflationary concerns in central bank communication. This trend indicates that, during the pandemic, central bank officials became increasingly worried about inflation developments.
Interestingly, towards mid 2022 the indexes started declining, indicating that inflationary concerns were reducing, perhaps as a result of growing confidence that the dis-inflation path was underway. This trend is particularly evident in the Q&A sessions scores. However, in the beginning of 2023 the scores surged again, possibly suggesting that the "dis-inflation journey" was more a "bumpy ride" rather than a "smooth journey". This concern later materialised as inflation "stalled" and proved more persistent following data released in 2023 Q3.
Recent developments.
Lately, it is only from the latest two readings of the ECB Fear Inflation scores that the ECB communication has turned less concerned. In this setting, the experienced "uncertainty cycles", e.g. transitions from periods of higher uncertainty to lower uncertainty may be the reason why ECB interest rate cuts were put on hold for so long.
At this stage the question remains: has the Euro-Area finally embarked on a sustained dis-inflation cycle? Time will tell.
The ECB Fear, Surprise and Topics Scores are part of our Central Bank E-monitor offering. Subscribe to gain valuable insights into ECB communication.
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