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In this speech by Mario Draghi, in section '2:Responding to high unemployment', and subsection 'Boosting aggregate demand', Mario states «Over the month of August financial markets have indicated that inflation expectations exhibited significant declines at all horizons. The 5year/5year swap rate declined by 15 basis points to just below 2% - this is the metric that we usually use for defining medium term inflation. »

How does the ECB get the markets inflation forecast with the 5y/5y swap rate?

Also in the same subsection of the text, there's 'Figure 7: Expected real interest rate path in the euro area and the US'. In this figure, the forecast is obtained from OIS-Inflation swap, according to the subtitle on the vertical axis. How do they obtain this? What's the rationale for it?

Any help would be appreciated.

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  • $\begingroup$ There are many sources of information on how inflation swaps work. $\endgroup$
    – Alex C
    Aug 14, 2016 at 11:47

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The section two remark likely refers to inflation swaps. In figure 7: OIS is a nominal rate index, subtracting from this the inflation rate on the inflation swaps gives a constructed real rate as written in the header. Real rate = (approx) nominal rate - imflation rate.

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  • $\begingroup$ The 5yr 5yr inflation swap is a forward swap, that is a swap starting in 5 years based on the inflation in the following 5 years (that is August 2021 to August 2016). $\endgroup$
    – Alex C
    Aug 14, 2016 at 21:52

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