Isolating a Measure of Ination Expectations of the South African Financial Market Using Forward Interest Rates

The ination expectations channel of the transmission mechanism has generally become recognised as crucial for the implementation of modern monetary policy. This paper briey reviews the practices commonly employed for measuring ination expectations in South Africa and o¤ers a market-based alternative with advantages over existing measures. It is widely recognised that the yield curve contains some information about the future ination expected by the markets. The availability of ination-indexed bonds in South Africa for the past few years has provided an opportunity to use more recently developed techniques for isolating a measure of ination expectations using the di¤erence between nominal and real forward interest rates (ination compensation). In this paper, the methodologies of Nelson and Siegel (1987) and Svensson (1994) are applied in order to determine a series of implied nominal and real forward interest rates. The di¤erence between the nominal and real forward rates on a particular day are then determined, and this is used as a measure of the ination expectations of the markets. This measure of ination expectations should not be viewed as a substitute for other measures of ination expectations, but should rather supplement these in order to o¤er an additional insight.