Inflation Targeting Rules and Seasonality Bias in Inflation Expectations

Inflation expectations estimates are among the most important indicators used, in particular when implementing the Taylor rule. These estimates include primarily (1) break even inflation for the next 12 months, calculated from the prices of CPI (Consumer Price Index)-indexed and unindexed government bonds, and (2) professional forecasters' projections for the next 12 CPI figures. This study shows how these two expectations estimates are affected by deviations caused by the seasonality inherent in the CPI. The first effect derives from the impact of seasonality on the pricing of CPI-indexed financial assets, including CPI-indexed bonds. The second effect derives from limited internalization of seasonal factors when forecasters' projections are formulated.We find that seasonal factors indeed have a strong, though not complete, effect on the pricing of CPI-indexed bonds. Taking these effects into account will improve the information used by monetary authorities in making their interest rate decisions