Break-even inflation, i.e. the inflation rate expected by a risk neutral investor, is composed of a pure expectation of inflation and an inflation risk premium, required by investors to hold assets whose value can be eroded by the price level growth. The work aims to compare the estimates of the two components of euro area break-even inflation obtained using alternative methodologies.
The methodology used by the Bank of Italy, which uses the yields of nominal government bonds and those indexed to consumer prices, shows that the decline in break-even inflation observed since October 2019 is mainly attributable to the decrease in inflation expectations against a stable premium for risk; conversely, the methodology that uses inflation swaps attributes the decline in break-even inflation to the decrease in the risk premium.
