The Inflation Conflagration Is Back And Here To Stay

Prices outside fuel and food are rising too, in the US, Australia and India. In Europe, businesses are planning further price increases and consumers expect to pay more over the coming year. Once those expectations take hold, they tend to become self-fulfilling: companies raise prices, and workers push for higher pay to keep up.

Central banks are responding. The European Central Bank has raised rates twice this year, the Federal Reserve has resumed hiking, and Australia, India and Indonesia have all tightened. Further increases look likely, too.

Higher rates can't produce more oil, though, and they take time to work. Policymakers are right to act, because letting today's price rises feed into wages would make the problem far harder to fix later. Even with their efforts, inflation looks likely to stay well above 2% for years.

For investors, the effects hit across their portfolios. Cash loses value fastest, of course. At the current US inflation rate, money earning nothing loses half its purchasing power in under 20 years. At India's rate, it takes around 13. Savers who think they're being cautious fall behind every month their interest rate trails the cost of living.

Bonds, long seen as the safe option, also come under pressure. A fixed return of 4% is worth very little when inflation runs close to that level, and each interest-rate rise reduces the market value of bonds already held.

The bigger risk is that shares and bonds fall together. Balanced portfolios rely on one cushioning the other. In 2022, the last time central banks raised rates this aggressively, both dropped sharply in the same year, and many investors who thought they were well diversified found far less protection than expected.

Shares carry their own risks, with highly valued growth companies tending to suffer most when rates rise. Businesses that can't pass higher costs on to customers see their profits squeezed, often just as those customers are cutting back to cover fuel, food and mortgage bills.

Borrowers are hit twice: first by higher living costs, then by the rising cost of their debt. Wealth can still be protected, though it takes active management.

Lower-risk, professionally managed strategies designed to keep pace with inflation at least leave investors far better placed than cash sitting idle. Real assets and businesses with genuine pricing power have historically held up best during long periods of rising prices.

The way the consensus misjudged this deserves attention. Two years ago, the dominant view in central banks and on trading floors was that 2022 was a one-off, driven by lockdowns and supply bottlenecks that wouldn't return. Rates had done their job, prices were easing, and the world was heading back to the low inflation of the 2010s.