Inflation Expectations: Why They Drive Prices and Wages

Why expectations about inflation can create inflation

When a supplier announces that it expects rising costs next year, it often raises its prices today. When employees expect life to become more expensive, they ask for more in the next pay round. Both happen before the higher inflation has actually arrived. Expectations are therefore not a side issue of inflation; they are one of its drivers.

After 2022 and 2023, when consumer prices in Germany rose by 6.9 and 5.9 percent, the question has become a practical one for businesses. This article therefore asks: How strongly do inflation expectations drive prices and wages, and how should an owner take them into account in planning? To answer it, we first clarify the terms and the thinking model of anchored expectations, then look at what surveys of firms show, weigh two readings, and finally derive a simple planning rule.

What are inflation expectations, and who holds which?

Inflation expectations are the rate of price increases that people and businesses expect for a given period, such as the next twelve months or five years. A distinction is made between short-term expectations, which react strongly to current prices, and medium- to long-term expectations, which show whether someone trusts the central bank to reach its target.

They are measured through surveys. For Germany, the Bundesbank surveys private individuals monthly; for the euro area, the ECB surveys firms quarterly in its Survey on the Access to Finance of Enterprises, SAFE for short. The figures differ considerably between groups, as the overview shows.

It is striking that all expectations are above the target. Private individuals even expect more inflation on average than is currently measured. This is not a peculiarly German phenomenon. In many countries, household expectations are above experts' forecasts, because people orient themselves strongly by prices they see often, for example at the gas station or in the supermarket.

The thinking model: anchored and unanchored expectations

Economics describes the relationship with the expectations-augmented Phillips curve. Put simply, it says that tomorrow's inflation depends on two things: how fully the economy is utilized and the inflation that everyone expects. Anyone who calculates with 4 percent sets prices and wages in a way that makes 4 percent more likely. Expectations thus have the character of a self-fulfilling prophecy.

From this follows the distinction that central banks care about. Anchored expectations stay close to the target even after a price shock, because everyone assumes inflation will fall again. A jump in energy prices then remains a temporary jump. Unanchored expectations, by contrast, take every shock as a sign of permanently higher inflation. Prices and wages then follow, and a one-off shock turns into persistent inflation.

An everyday analogy: a ship at anchor sways in the wind but returns to its place. A ship without an anchor drifts a little further with every gust, even when the wind subsides. Expectations are the anchor of price developments. Central banks and trust in money describes why this anchor depends on trust in the central bank.

Inflation that everyone expects has already half arrived.

What surveys of firms show

For a country's prices, firms' expectations matter particularly, because firms set the prices. Schwartzman and Waddell (2024) analyze a quarterly survey by the Federal Reserve Bank of Richmond among businesses in the southeastern US, with nine waves from July 2021 to October 2023. Three findings are instructive for owners.

• Attention follows inflation. The share of firms that do not follow inflation at all fell from over 20 percent in July 2021 to just over 10 percent in July 2022. The share following it very closely rose from about 20 to about 35 percent. By October 2023 this had partly reversed.
• Expectations flow into prices. Firms that expected higher general inflation also planned higher price increases of their own. The authors stress, however, that the explanatory power is limited: inflation expectations are one of many factors.
• The effect depends on the state of the economy. The higher inflation was, the more firms described their expectations as very important for their own prices. As inflation fell, this effect largely faded.

The authors themselves name a limitation: many firms took part in several waves and may have become more attentive through the survey itself. The average inflation expected by the surveyed firms fell from almost 7 percent in July 2022 to a little over 4 percent in 2023, but remained above the level before the inflation wave.

A study by Norway's central bank comes to a similar result. Using quarterly survey data, Lindalen and Mjølnerød (2026) show that the inflation expectations of business leaders are clearly related to actual domestic inflation and improve short-term forecasts, especially since 2020, when inflation and expectations fluctuated more.

Costs or inflation: what firms really keep an eye on

An important qualification comes from Meyer and Sheng (2025). They argue that firms think less about the general inflation rate when setting prices than about their own unit costs. In a survey of decision-makers at US firms, they therefore asked about expected costs per unit. These cost expectations were clearly related to firms' own prices and predicted inflation at least as well as professional forecasts.

An experiment in the same study is remarkable. When firms were given information about general inflation or the central bank's forecasts, they barely changed their cost expectations. For their own prices, what counts is what a business knows about its costs, not what is in the newspaper.

In addition, passing on costs is asymmetric. Demirhan (2025) shows with survey data from Turkish manufacturing that firms raise prices faster than they lower them, which prolongs inflation. This matches the Swiss finding described in After inflation: rising costs are passed on more often than falling ones.

How expectations affect wages

The second channel is wages. Employees and unions negotiate with an eye on expected inflation, because a 3 percent pay rise at 4 percent inflation is a real loss. If wages rise, businesses' costs rise, and prices follow. This cycle is often called a wage-price spiral. Whether it actually starts depends on whether both sides expect permanently high inflation or a return to the target.

The ECB's survey of firms shows easing in the second quarter of 2026. Firms surveyed in the euro area expected average wage increases of 2.5 percent over the next twelve months, after 2.8 percent in the previous round, and selling price increases of 3.2 percent, after 3.5 percent. A total of 5,087 firms were surveyed, 92 percent of them with fewer than 250 employees.

The guide Conducting salary conversations describes how to handle pay demands in your own business. Collective agreements and the minimum wage explains the role that collective agreements and the statutory minimum wage play.

Two readings: are expectations still anchored?

The data allow two readings, and both have good arguments.

The reassuring reading: at 3.1 percent in the second quarter of 2026, firms' medium-term expectations were above the target, but they barely moved, even though energy prices rose markedly because of the situation in the Middle East. Wage expectations fell. This suggests that most firms see the price shock as temporary.

The cautious reading: all measured expectations have been above 2 percent for years, and those of private individuals are even above actual inflation. In the survey round for the third quarter of 2026, expectations in the full sample rose markedly according to the ECB, while they remained broadly unchanged among firms that had already taken part in the previous round. The ECB itself points out that the composition of the sample changed substantially, making the figures difficult to interpret.

I consider the reassuring reading the better supported one, because it relies on comparable participants. For a business, however, the second reading is the more useful caution: the anchor holds, but it sits higher than before 2022. Anyone planning with 2 percent is planning more optimistically than most market participants expect. The rate turnaround for SMEs describes what the higher interest rate environment means for investment and company values.

What you can derive for your planning

From the findings I derive a rule I call costs before headlines: expectations should enter your planning, but as expectations about your own costs, not as a general inflation figure. Four steps are enough.

1. Write down cost drivers

   List the three to five costs that most strongly determine your unit costs, such as personnel, materials, energy, and freight, with their approximate share.

2. Set an expectation for each driver

   Estimate the change for each driver over the next twelve months and note what the estimate is based on: collective agreement, supplier announcement, futures price, experience.

3. Calculate the weighted cost expectation

   Multiply share by expected change and add up the results. This is your own inflation expectation for the business.

4. Compare every six months

   Every six months, compare expectation and actual development. This shows you whether you systematically estimate too high or too low.

In this worked example, the business's cost expectation is 3.5 percent, well above the current inflation rate. Anyone who aligns prices only with the official rate loses margin. Raising prices without losing customers describes how to prepare and communicate a justified increase.

Conclusion: expectations drive prices, but through costs

To the guiding question: inflation expectations drive prices and wages because firms and employees act today according to how they assess the future. But the findings also show the limits of this channel. Firms pay attention to inflation mainly when it is high, and for their prices their own cost expectations count more than general forecasts. At the moment, the data point to expectations that are anchored, but at a higher level than before 2022.

For owners, this implies no speculation about the next inflation figure, but a sober duty to do their own calculation. If you know your cost drivers, you do not need the headline.

• Write down the main cost drivers with their share of unit costs.
• Record a justified twelve-month expectation for each driver.
• Use the weighted cost expectation as the basis for price and wage planning.
• Compare expectation and actual development every six months.