Rethinking inflation: Why inflation protection matters

We believe these people are wrong. The global economy appears to have transitioned into a more inflationary regime. Although each uptick in inflation is blamed on temporary shocks, it is really being driven by deeper structural forces.

This has significant implications for asset allocation, portfolio construction and risk management, particularly for Australian investors navigating an open economy exposed to the global commodity cycle.

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The inflation outlook has deteriorated

The period of disinflation that followed the post–pandemic inflation spike has now largely run its course. The pace of inflation naturally moderates after large upward shifts due to base effects, as earlier spikes in food and energy prices fade from annual comparisons. However, inflation has since stabilised at levels above central bank targets across most major economies, including the UK and US. This was before recent developments in the Middle East, which added fresh upward pressure via higher energy prices.

Despite this, central banks have demonstrated a bias towards easing policy as soon as inflation appeared to peak. While this reflects a desire to support growth, it also means they have simply accepted a permanently higher price level. This has eroded purchasing power and embed more persistent inflation through wage dynamics.

This can create a self-reinforcing cycle, making inflation harder for central banks to control. Some long-term inflation expectations have already edged higher, raising the risk that second-round effects are becoming embedded.

Seven forces reshaping the inflation outlook

In our view, there are seven structural trends that we expect to compound the problem.

First, policy activism has become entrenched. Governments have moved from emergency support during crises to a more permanent willingness to intervene, with ongoing deficits and rising debts. While this has stabilised demand, it has also prevented the natural adjustments that would otherwise bring inflation lower.

Second, geopolitics and security concerns are top of the political agenda. Increased defence spending, fragmentation into competing regional blocs, and the reframing of trading partners as strategic competitors all point towards higher costs and sustained fiscal pressure.

Third, rising government debt is becoming a political constraint. As debt burdens grow, there is greater incentive for policymakers to tolerate higher inflation as a means of reducing real liabilities.

Demographics also matter. Ageing populations, declining labour supply and rising dependency ratios are likely to generate upward pressure on wages and service inflation over time.

At the same time, globalisation is reversing. The shift towards re-shoring and supply-chain resilience reduces efficiency and removes a key disinflationary force that dominated the early 2000s.

Decarbonisation adds another layer. The scale of investment required to transition the global energy system to a greener future will put pressure on costs in the near to medium term.

Finally, while artificial intelligence may ultimately be disinflationary, its immediate impact is likely to be the opposite. The infrastructure buildout, demand for energy and skilled labour, and competition for resources all point to near-term inflationary pressure.

Taken together, these forces suggest that inflation is likely to remain elevated and more sensitive to supply shocks than in the past.

Implications for investors

For investors, the key risk is to remain anchored to the low-inflation era that followed the global financial crisis. There is a natural tendency to expect a return to familiar conditions, but structural change rarely works that way.

Historically, such shifts follow a predictable pattern – early signals are dismissed as temporary, conflicting data accumulates, and eventually markets adjust, often abruptly.

If inflation proves structurally higher, there are several implications. Inflation volatility may remain elevated, real yields could settle at higher levels than investors have become accustomed to, and regional dispersion may increase as domestic dynamics diverge. It’s critical to prepare for this.

Building inflation resilience

For investors, the challenge is to adapt to a world where inflation is more persistent and volatile and consider ways to mitigate this. In this environment, incorporating inflation protection into portfolios becomes increasingly important. Traditional approaches include inflation-linked bonds and derivative strategies such as swaps.

However, a broader perspective may also be required. Active management, with the flexibility to adjust exposures as the inflation outlook evolves, can play a valuable role.

For Australian investors in particular, this may also mean reassessing allocations across global and domestic assets, recognising that these new inflation dynamics are not just a risk, but can also result in global opportunities.

This article was provided by David Hooker, senior portfolio manager, Insight Investment