How well do inflation swaps reflect expected inflation?

Inflation swaps are financial instruments used for the purpose of hedging against future inflation. Inflation expectations extracted from inflation swaps are often used as a measure of the market’s inflation expectations, but the evolution of the swaps does not always correspond to actual changes in inflation expectations. When the market’s expectations are assessed on the basis of inflation swaps, it is important to pay attention to the specific features of these agreements. Consequently, in assessing changes in short-term inflation expectations, forward inflation (e.g. annual inflation one year ahead) should be used rather than inflation swap rates.