What to know about inflation

  • 13 July 2022 (3 min read)
Inflation video series : Module 1 – What to know about inflation

What to know about inflation

Against a backdrop of squeezed supply chains, increased levels of demand as pandemic-related restrictions are eased and geopolitics, inflation has risen to levels not seen in some countries for over twenty years. With it likely to remain at high levels, it is important to remember the key elements about inflation and ways to mitigate against it.

What is Inflation?

Inflation is the term used to describe a rise in the general level prices.  As prices rise, people’s ability to purchase goods and services (known as purchasing power) falls.  How quickly prices rise is called the rate of inflation – it is quoted as a percentage and is measured on a monthly basis using price indices.  

When the rate of inflation is decreasing but is still positive we call it disinflation.  When the rate is negative (which means that prices are falling) we talk about deflation

Price indices use a “basket” of goods and services that people regularly spend money on such as food, transport and clothing.  The month’s prices are then compared with what it was a year ago to work out the current inflation rate.  According to its components there are two categories:

  1. core inflation which is more representative of the structural evolution of prices (excludes volatile elements such as  food and energy)
  2. headline which is the total inflation.  Inflation-linked bonds are linked to headline inflation which includes energy and food prices.

While calculation methods may vary across countries, the majority of mature countries, including the US and UK, use CPI (Consumer Price Index). In the European Union, all countries follow the same methodology called ‘Harmonised Index of Consumer Prices (HICP).

All these measures relate to realised, or past inflation.  However, when trading inflation-linked bonds, investors have their own forecast of what inflation will be in the future: market-based inflation expectations which is what we call “inflation breakeven”. Part four of this series, Market conditions and when to use inflation-linked bonds, will study this in more detail.

There are several factors that can cause inflation, money supply growth outstripping level of productivity, excess demand, rising costs, weak currency causing imports to be expensive, and even just the anticipation of inflation can cause inflation.

Whatever the cause, it no longer is a localised event. The old saying ‘If the US sneezes, the rest of the world catches a cold’ holds true for inflation as inflation is very correlated across countries. This is because of the globalization of the economy, global pricing of raw materials and the integration of economic cycles.

Global Inflation Rate
Source: AXA IM, Datastream. For illustrative purposes only

This means that when it comes to mitigating the effects of inflation, there is a diversification benefit in taking a global approach. On top of this, as can be seen in the chart below, global inflation-linked bonds can provide a better risk-adjusted return than many local inflation strategies.

Inflation Linked Bonds: 10-Year Risk / Return Picture
Source: AXA IM, Barclays as at 31/05/2022 – for illustrative purposes only. Developments of the past offer no guarantee and are no indicator for any future returns or trends.

As this module has shown, there are many different causes for inflation and a variety of measurements that can be used to calculate inflation.  It is worth investors reviewing the effects of inflation on their portfolio from a global perspective, not just their local market. With this in mind, the second in our series, Adding to the toolkit: inflation-linked bonds will look in more detail at inflation-linked bonds and how they can be used as an investment solution for offsetting the impacts of inflation.

Fixed income

Inflation

Inflation can erode the real returns of investments however tools like inflation-linked bonds could help investors mitigate the effects of inflation on their portfolio.

Find out more

Watch the other modules from our inflation series

The objective of this series is to make inflation-linked bonds investing simple to investors.

    Disclaimer

    This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.

    Due to its simplification, this document is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this document is provided based on our state of knowledge at the time of creation of this document. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.