First COVID. Then the Ukraine war. Then tariffs. Now the Iranian war. Plus massive government deficits in many countries. At some point, the concern is that inflationary expectations are going to be permanently embedded into consumers' and workers' psyches. At that point central banks might need to cause some real economic damage in order to reset expectations.
There are two ways to consider reversion:
1. While central banks will force inflation back to 2%, prices will remain structurally higher.
2. Prices have been temporarily shocked, but will return to the prior trend
Goods tend to be more likely to be in the second category, services more likely to be in the first.
The shape of future inflation or deflation depends on how many things you think will fit into each profile.
In most service categories, and in food, it appears that higher inflation is already embedded:
Goods, is almost different - but policy decisions are causing higher inflation in both Australia and the US:
Energy is much more volatile and about to become more so. The biggest issue for Australia is that despite having an incredible amount of energy, a political decision has been made to open Australia up to world prices. Embedding higher inflation.
Can the RBA use higher interest rates to bring down world energy prices? No it can't. Which means it will need to damage the rest of the economy to tame inflation.
What should you do within your portfolio?
Long term, more equities, more inflation-linked bonds. But in the short term, there are other considerations. More on that another day.
