Inflation Outlook

Inflation Outlook
October 28, 2016

This document contains a selection of charts that are the output of Fulcrums quantitative
toolkit for monitoring the global economy and financial markets. All of our forecasts and projections are the output of formal econometric models that have been developed in the academic
literature, and therefore contain little input from direct judgement. All charts and models are
up to date with available data up to October 28, 2016.a

Table of contents
Inflation

Short-term inflation forecasting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Market measures of inflation expectations . . . . . . . . . . . . . . . . . . . . . . . .

More details of the specific models, and intra-month updates, are available upon request.

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Inflation Outlook

Inflation
Short-term inflation forecasting
Fulcrum short-term inflation forecasting models
The following charts present inflation forecasts estimated using Bayesian Vector Autoregressive Models (BVARs). For each country, the model includes: headline inflation, core
inflation, the oil price and the trade weighted exchange rate. We use Minnesota priors,
as in Doan, Litterman, and Sims (1983), to shrink the coefficients of the BVAR towards
a more parsimonious specification.
How to read the graphs
The following charts display the predictive distribution of inflation for the next two years
in the form of fan charts.
The solid red line represents the most recent median forecast of inflation and the dark
and the light red areas around it represent respectively the 68% and the 90% confidence
bands.
The blue dots represent the forecasts published by the policy makers.
The black dashed line represents the forecasts implied by the inflations swaps.
Notes and data definitions
Headline inflation: USA: PCE deflator; Euro Area: HICP inflation; Canada: CPI;
Switzerland: CPI; Japan: CPI; Sweden: CPI; UK: CPI.
Core inflation: USA: PCE excluding food and energy; Euro Area: HICP excluding Energy, Food, Alcohol and Tobacco; Canada: CPI excluding food and energy;
Switzerland: CPI excluding petroleum products; Japan: CPI excluding food, beverages and energy; Sweden: CPI with fixed interest rates excluding energy; UK:
CPI excluding energy, food, alcoholic beverages and tobacco.
The USA model includes CPI and core CPI inflation as additional indicators.
We exclude VAT increases by assuming full and immediate pass-through on the
month of implementation.

Sources: Fulcrum calculations based on Haver Analytics data.

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Inflation Outlook
Inflation Forecasts from a Bayesian VAR (% 12 month change)

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Inflation Outlook
Inflation Forecasts from a Bayesian VAR (% 12 month change)

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Inflation Outlook

Market measures of inflation expectations

Definitions
Five year inflation-linked swap rates
The swap rates are linked to CPI inflation in the US, HICP inflation in the Euro Area
and RPI inflation in the UK. The horizontal dashed line represents the policy makers
target. In the case of the US and the UK we have added 0.5% and 0.6% to reflect the
average bias of US CPI and UK RPI over the inflation measures targeted by the Federal
Reserve and the Bank of England (respectively PCE inflation and CPI inflation).
Inflation protection
The inflation protection is an annual inflation cap of 4% over 5 years.
Deflation protection
The deflation protection is an annual inflation floor of 0% over 5 years.
Developments should be interpreted with caution due to limited market liquidity.

Sources: Fulcrum calculations based on Bloomberg data.

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Inflation Outlook
Market Inflation Expectations (derived from swaps)

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Inflation Outlook

References
Doan, T., R. B. Litterman, and C. A. Sims (1983): Forecasting and Conditional Projection
Using Realistic Prior Distributions, NBER Working Papers 1202, National Bureau of Economic
Research, Inc.

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Inflation Outlook
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October 28, 2016