Inflationlinked

Inflationlinked is a term used for financial instruments whose payments depend on an inflation index, typically the consumer price index (CPI). The term covers inflation-linked government bonds, inflation-linked corporate bonds, and related inflation-indexed derivatives.

In inflation-linked bonds, principal and sometimes coupon payments are adjusted in line with the index. The coupon is usually calculated on the inflation-adjusted principal, so payments rise with inflation and fall with deflation. At maturity, investors receive the greater of the original principal or the inflation-adjusted principal, providing some protection against deflation. Different markets use different indices, such as CPI, CPIH, or RPI.

Prominent examples include the United States Treasury Inflation-Protected Securities (TIPS) and the United Kingdom’s Index-Linked Gilts. We also see inflation-linked notes and bonds in other economies, as well as inflation-linked swaps and other derivatives used to hedge inflation exposure.

Purpose and use: investors seek to preserve purchasing power and obtain a real return, particularly for pensions and insurers with long horizons. Valuation depends on expected inflation and real interest rates, so prices reflect inflation expectations and market liquidity.

Risks include index measurement risk, deflation risk (though limited by floor rules in some instruments), liquidity risk, and potential negative real yields if inflation expectations remain low. A common tool is the break-even inflation rate, calculated from the yield difference between nominal and inflation-linked bonds.