While inflation expectation metrics have garnered significant attention, UBS argues that central banks should disregard consumer and corporate surveys on the subject and focus exclusively on financial market inflation expectations when formulating monetary policy.

Brent crude futures—the global benchmark—have surged more than 71% year-to-date after the US and Israel launched a joint strike on Iran in late February, triggering an inflation shock and compelling institutions like the European Central Bank to raise interest rates.

In the US, the latest government data released this week showed the Consumer Price Index (CPI) rising 3.4% year-on-year in August, while the Producer Price Index (PPI) climbed 5.4% year-on-year. Components of both indices factor into the Federal Reserve’s preferred inflation gauge: the Personal Consumption Expenditures (PCE) price index. The PCE reading has remained above the Fed’s long-term 2% inflation target for 65 consecutive months.

"The rise in oil prices has sparked a sudden surge of interest in inflation expectations. Recently, global Google Trends search interest for the word 'inflation' was nearly double the level seen during the post-pandemic inflation spike. Financial market participants are vaguely recalling economics lessons from decades ago and assuming that inflation expectations matter," Paul Donovan, Chief Economist at UBS, wrote in an analytical note this week. "Central bankers cite inflation expectations to justify raising rates. But in a world of social media memes and plummeting survey response rates, inflation expectations may not matter all that much," he added.

"Inflation expectations mean nothing in isolation. Expectations only matter if they lead to changes in economic behavior. In economics, if people say one thing but do another, it is actions that count, not words. An excessive focus on inflation expectations can lead to policy errors," Donovan emphasized.

US CPI and PPI data released this week were the final straw, definitively tipping Wall Street expectations toward a 25-basis-point rate hike by the Federal Open Market Committee (FOMC) on Wednesday. Expectations of tighter policy weighed on Wall Street and triggered a sharp rise in US Treasury yields.

Meanwhile, the University of Michigan’s latest consumer sentiment report showed that one-year-ahead inflation expectations rose to 4.6% in September from 4.0% in August—the highest level since June.

"Consumer inflation expectations matter if consumers have leverage over wages or if they alter spending patterns in response to higher inflation expectations. Corporate inflation expectations matter if companies have pricing power or if they adjust pricing strategies in anticipation of future cost increases," Donovan said.

"Investor inflation expectations are the most important, as investors are the ones most likely to have the ability to act—and act quickly. Inflation expectations can influence both the relative value of various assets and the real cost of capital in the economy," he added. A UBS analyst noted that it is currently unlikely for consumers or companies to translate inflation expectations into actual economic consequences. At the same time, investors' inflation expectations represent a "more significant" factor.

"It is quite possible that investors (focused on the broad inflation picture) will hold different expectations than borrowers (guided by inflation experiences at the company level), which could constrain investment," Donovan said.

"For now, central bankers should probably disregard inflation expectations derived from consumer and corporate surveys and focus specifically on financial market expectations when formulating monetary policy," he concluded.