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    Inflation update: A structural deterioration in the inflation outlook

    Inflation update: A structural deterioration in the inflation outlook

    22 August 2024 Fixed income

    Investors are increasingly confident that global central banks have tamed inflation and can begin cutting rates aggressively, but we believe those looking for aggressive cuts may be disappointed.

    • The outlook for inflation appears to have structurally deteriorated around the world:
       
      • The demographic outlook is a problem. Aging populations and rising dependency ratios mean economies will be ever more driven by consumers rather than producers, pushing inflation upwards.
      • In an increasingly bi-polar world, the era of ever-cheaper goods imported from China is over. Deglobalisation and the reshoring of production is the new trend and it’s going to mean less efficient production and higher costs of production are here to stay.
      • Big government has become psychologically embedded. Politicians, voters and even central banks have become used to spending money to counter problems, artificially boosting aggregate demand and preventing the natural role of capital markets in bringing periodic change.
      • The energy transition and higher defence spending are two structural problems that will further boost demand and compound fiscal deficits.

    • Artificial intelligence (AI) could save the day, but the uncertainty is high. AI is a revolutionary new technology which could result in huge productivity gains, but it may take decades for the full impact to become clear.

    • Structurally higher inflation would be uncomfortable for central banks and politicians. If central banks stick to current inflation targets, then a structural rise in underlying inflationary pressures would require interest rates to be maintained at higher levels than seen since the global financial crisis. This is likely to bring politicians and central bankers into conflict and we think pressure will grow to weaken inflation targets.

    • In this scenario, holders of inflation-linked assets are likely to do well.
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