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Navigating with a Compass: Charting the Course of Underlying Inflation

Author

Listed:
  • Nuno Lourenco

    (Banco de Portugal)

  • Joao Quelhas

    (Banco de Portugal and Nova SBE)

  • Antonio Rua

    (Banco de Portugal and Nova SBE)

Abstract

We propose a novel tool to gauge price pressures resorting to circular statistics, the inflation compass. It offers a reliable indication of inflationary pressures in the euro area since its inception. Unlike most alternative measures of underlying inflation, the inflation compass does not exclude any inflation subitems. Moreover, it is not revised, providing real-time signals about the course of underlying inflation. We also provide evidence of the usefulness of the inflation compass to forecast overall inflation, even during periods of increased turbulence, such as the COVID-19 pandemic or the recent inflation surge. Lastly, our approach can handle large-dimensional data straightforwardly.

Suggested Citation

  • Nuno Lourenco & Joao Quelhas & Antonio Rua, 2025. "Navigating with a Compass: Charting the Course of Underlying Inflation," International Journal of Central Banking, International Journal of Central Banking, vol. 21(3), pages 293-326, July.
    • Handle: RePEc:ijc:ijcjou:y:2025:q:3:a:7
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    References listed on IDEAS

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    1. Clark, Todd E. & West, Kenneth D., 2007. "Approximately normal tests for equal predictive accuracy in nested models," Journal of Econometrics, Elsevier, vol. 138(1), pages 291-311, May.
    2. Koester, Gerrit & Lis, Eliza & Nickel, Christiane & Osbat, Chiara & Smets, Frank, 2021. "Understanding low inflation in the euro area from 2013 to 2019: cyclical and structural drivers," Occasional Paper Series 280, European Central Bank.
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