<p>To answer your question you have to understand Eurozone fixed income market structure:</p>

<ol>
<li><p>The ECB's mandate is to maintain price stability for the entire Eurozone.  Other measures of inflation---for instance the difference between French fixed-rate OATs (Obligations Assimilables du Tresor) and OAT linkers---measure only regional inflation, and suffer potentially from artifacts related to low liquidity.</p></li>
<li><p>Capital mobility within the Eurozone is quite good.  The EU banking sector dominates swaps trading volume, and the interest rate swaps market is extremely deep and liquid.  Therefore the swaps rate reflects Eurozone wide term structure.  What's more, fixed income traders tend to quote Euro pay issues' spreads off of swaps.  They are the benchmark rate.</p></li>
<li><p>There are EFSF (European Financial Stability Facility) and ESM (Eurpoean Stability Mechanism) bonds which also price to reflect Eurozone-wide term structure.  However these SPVs have not issued linkers, so it's impossible to use them to price inflation.</p></li>
<li><p>Some commenters here have forgotten their fixed-income math.  You can price counterparty risk-free interest rate swaps directly from fixed term structure.  This is because in an arbitrage free world Treasury curves reflect market participants expectations for forward rates and swap rates.  Any answer that suggests that swaps compensate for premiums and risks that are not purely term-structure related is false.</p></li>
<li><p>Swap rates pre-Dodd-Frank/MIFID used to reflect bank credit risk.  Now that they are centrally cleared in Swap Execution Facilities (SEFs), any credit risk associated with the swap is paid in margin, not as an interest rate premium.</p></li>
<li><p>The choice of term and tenor (5y/5y) is arbitrary.  The Federal Reserve also uses 5y/5y forward breakevens.</p></li>
</ol>

<p>I hope this clarifies that the 5y/5y inflation rate swap is the only sufficiently liquid measure of Eurozone-wide inflation.</p>

CC BY-SA 3.0
2016-12-03T13:00:05.117Z
An interesting answer but am not sure how a swap can measure inflation at a more basic level?
Trajan
CC BY-SA 3.0
2016-12-03T15:37:49.800Z
@Jurassic.  You're right, a plain vanilla interest rate swap wouldn't do it, but an inflation swap would.  Investopedia has a good explanation of inflation rate swaps.  This document http://the.earth.li/~jon/junk/kerkhof.pdf is also very thorough.
CAMELS
CC BY-SA 3.0
2016-11-29T03:47:37.437Z
2016-11-29T03:52:53.417Z
2016-11-29T03:52:53.417Z
CAMELS
<p>There's one way, albeit not from interest rates futures. From fisher's approximation $i=r+\pi^E$, and thus if I know the nominal interest rate from a regular government bond, and subtract the (real)interest rate of an inflation protected bond - like TIPS - we get the market's expected inflation forecast. </p>

CC BY-SA 3.0
2016-08-13T21:22:39.583Z
2016-08-22T17:13:44.047Z
2016-08-22T17:13:44.047Z
An old man in the sea.
<p>The key interest rate gives a direction on the cost of money. This rate influences the entire money supply and the cost of money for
banking intermediaries.</p>

<p>This is the overall economy of an area that is influenced by the decisions of the monetary policy of the European Central Bank.</p>

<p>You have the right to ask questions of the economists of the European Central Bank directly on the website of this monetary institution. They are not obliged to respond.</p>

<p>When the interest rate is reduced, the central bank hopes to stimulate the economy by monetary irrigation.</p>

CC BY-SA 4.0
2016-08-06T08:34:15.807Z
2019-06-25T17:17:44.920Z
2019-06-25T17:17:44.920Z
Aymen Fassi
<p>I cannot understand why the 5y5y swap rate measures inflation. I can see how the floating rate somewhat measures the rate of interest rates which are related to inflation. However I cannot understand why this swap rate is the preferred way to measure (medium term) inflation expectations.</p>

<p>For more information see <a href="http://www.itcmarkets.com/news-press/itc-egbs-questions-regarding-draghis-reference-to-5y5y-forward-rate-and-inflation" rel="nofollow">here</a>.</p>

CC BY-SA 4.0
2019-06-14T20:25:07.793Z
Link is now broken
Marco Demaio
<macroeconomics><inflation><interest-rate><central-banking>
Why does the European Central Bank use the 5y5y rate to measure inflation
Trajan
# Why does the European Central Bank use the 5y5y rate to measure inflation

(Asked by: username_0 on 2016-07-16)

I cannot understand why the 5y5y swap rate measures inflation. I can see how the floating rate somewhat measures the rate of interest rates which are related to inflation. However I cannot understand why this swap rate is the preferred way to measure (medium term) inflation expectations.

For more information see [here](http://www.itcmarkets.com/news-press/itc-egbs-questions-regarding-draghis-reference-to-5y5y-forward-rate-and-inflation).

**Tags:** macroeconomics, inflation, interest-rate, central-banking
> **Comments:**
> **username_1**: Link is now broken  

---

## 3 answers

### Answer by username_2 on 2016-11-29. Score: 2 | Accepted answer

To answer your question you have to understand Eurozone fixed income market structure:

1. The ECB's mandate is to maintain price stability for the entire Eurozone. Other measures of inflation---for instance the difference between French fixed-rate OATs (Obligations Assimilables du Tresor) and OAT linkers---measure only regional inflation, and suffer potentially from artifacts related to low liquidity.
2. Capital mobility within the Eurozone is quite good. The EU banking sector dominates swaps trading volume, and the interest rate swaps market is extremely deep and liquid. Therefore the swaps rate reflects Eurozone wide term structure. What's more, fixed income traders tend to quote Euro pay issues' spreads off of swaps. They are the benchmark rate.
3. There are EFSF (European Financial Stability Facility) and ESM (Eurpoean Stability Mechanism) bonds which also price to reflect Eurozone-wide term structure. However these SPVs have not issued linkers, so it's impossible to use them to price inflation.
4. Some commenters here have forgotten their fixed-income math. You can price counterparty risk-free interest rate swaps directly from fixed term structure. This is because in an arbitrage free world Treasury curves reflect market participants expectations for forward rates and swap rates. Any answer that suggests that swaps compensate for premiums and risks that are not purely term-structure related is false.
5. Swap rates pre-Dodd-Frank/MIFID used to reflect bank credit risk. Now that they are centrally cleared in Swap Execution Facilities (SEFs), any credit risk associated with the swap is paid in margin, not as an interest rate premium.
6. The choice of term and tenor (5y/5y) is arbitrary. The Federal Reserve also uses 5y/5y forward breakevens.

I hope this clarifies that the 5y/5y inflation rate swap is the only sufficiently liquid measure of Eurozone-wide inflation.

> **Comments:**
> **username_0**: An interesting answer but am not sure how a swap can measure inflation at a more basic level?  
> **username_2**: @Jurassic.  You're right, a plain vanilla interest rate swap wouldn't do it, but an inflation swap would.  Investopedia has a good explanation of inflation rate swaps.  This document http://the.earth.li/~jon/junk/kerkhof.pdf is also very thorough.  

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### Answer by username_3 on 2016-08-13. Score: 1

There's one way, albeit not from interest rates futures. From fisher's approximation $i=r+\pi^E$, and thus if I know the nominal interest rate from a regular government bond, and subtract the (real)interest rate of an inflation protected bond - like TIPS - we get the market's expected inflation forecast.


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### Answer by username_4 on 2016-08-06. Score: -1

The key interest rate gives a direction on the cost of money. This rate influences the entire money supply and the cost of money for
banking intermediaries.

This is the overall economy of an area that is influenced by the decisions of the monetary policy of the European Central Bank.

You have the right to ask questions of the economists of the European Central Bank directly on the website of this monetary institution. They are not obliged to respond.

When the interest rate is reduced, the central bank hopes to stimulate the economy by monetary irrigation.


---

