What drives consumers’ inflation perceptions in the euro area?

Survey data shows consumers tend to think that inflation is higher than it actually is. Inflation perceptions by consumers may influence economic and financial decisions of households and so understanding what drives perceptions is an important question. This Letter examines which goods and services are driving inflation perceptions of consumers in the euro area. Various components of the Harmonised Index of Consumer Prices (HICP) – the official measure of consumer price inflation in the euro area - are considered as well as the index of residential property prices, which is not part of the HICP. The main findings are as follows. Firstly, consumers appear to have a different basket of goods and services in mind from that used in the HICP when forming their views on consumer price developments. Some goods and services are likely being disregarded. Secondly, inflation perceptions are driven by price developments in a number of HICP items covering a relatively broad range of goods and services. For some price indices, however, the relative importance in determining perceived inflation differs from the relative weight in the HICP. In addition, residential property prices are also important in explaining perceived inflation. Finally, it appears that consumers may find it difficult to adjust observed prices for changes in quality. From a policy perspective, more communication on what the official inflation measure is and how it is constructed may help to reduce the bias in consumers’ perceptions. This is important as perceptions of inflation may influence decisions to save and spend.