“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hitman,” former US president Ronald Reagan said as the US battled soaring inflation in the early 1980s. Since then, governments have largely kept inflation under lock and key. It has gradually been falling for decades, which has driven the value of growth assets such as shares higher. But as economies re-emerge from the pandemic, inflation is rising again. Inflation in Australia jumped to 3.8% in the second quarter of the year, up from just 1.1% in the first1 . Meanwhile, US inflation rose by 5.4% in June year-on-year, the fastest pace in 30 years2 . Should investors be concerned or is the spike just transitory after the pandemic? “That’s the million-dollar question,” says ClearView Chief Investment Officer Justin McLaughlin. “The short answer is no one really knows. But I think it’s going to be transitionary. If you look at the RBA’s forecast, they clearly think there will be a fairly modest increase in inflation at best.” Why falling inflation has been good for investors Falling inflation usually prompts central banks to cut interest rates, which fires up the economy. It is easier for businesses to borrow money to invest and hire new staff, while consumers with loans such as mortgages pay less interest, leaving them with more money to spend. The average rolling 12-month return for global equities when inflation was trending down over the last five decades was 10.4%, according to a SSgA report3 . When inflation was rising, annualised returns fell to just 5.3%. Central banks have taken interest rates to around zero (and in some cases negative) in the years since the global financial crisis in 2008-09, providing a powerful tailwind for equities. However, productivity and wages growth have remained stubbornly low. The pandemic which struck in early-2020 presented a new challenge. With little monetary policy ammunition left, governments have unleashed record spending programs aimed at pumping up their shutdown economies. But while inflation has since rebounded strongly, McLaughlin suggests it may largely be because inflation was so low (or even deflationary) during the pandemic lockdown. Supply chain bottlenecks, caused by production companies trying to keep up with newfound consumer demand, may also be driving higher inflation. 

“We might continue to have an inflationary spike as things reemerge this year,” McLaughlin says. “But we don’t expect inflation to rise again and again, year after year. To get sustained inflation the economy needs wages growth and that’s quite a bit of a challenge for Wall Street and, in Australia, George Street.”