Inflation is a key driver of investment returns. Understanding its dynamics can significantly enhance your investment strategy. This article reviews the current landscape of global inflation, provides inflation forecasts, and deconstructs inflation expectations as part of a capital market expectations process for asset allocation.
1. Structural Inflation
Each country typically has an inflation target set by its central bank or monetary authority. This target represents the desired level of inflation that the country aims to achieve over the medium to long term. For example, the Federal Reserve in the United States targets a 2% inflation rate, similar to the European Central Bank. These targets are set to provide a stable economic environment, fostering growth while preventing the economy from overheating.
In the graph provided, we summarize the inflation targets of a sample of countries. Where the target is a band, as in South Africa where it is 3-6%, the mid-point of the target range is used. Certain countries—specifically Hong Kong, the Philippines, Singapore, and Taiwan—do not have explicit inflation targets. For these countries, the median of the last 20 years of inflation outcomes is used to estimate the structural inflation.
The graph also disaggregates structural inflation into the US inflation target plus an inflation differential, which is the country’s inflation target minus the US target inflation. This approach is sensible because it normalizes inflation expectations against a stable benchmark, allowing for easier comparison across different countries. The US inflation target of 2% serves as a baseline, and the inflation differential highlights how each country’s target deviates from this benchmark.
Structurally high inflation in emerging markets is a multifaceted issue, stemming from a combination of economic, structural, and political factors. For instance, Turkey’s high inflation has been influenced by political instability, exchange rate depreciation, and economic policies that have sometimes prioritized growth over inflation control. The reliance on imported goods and energy has also made Turkey vulnerable to external price shocks.
On the other hand, India’s inflation has been driven by supply-side constraints, such as infrastructure bottlenecks and agricultural inefficiencies. Additionally, fluctuations in food prices, which constitute a large portion of the consumer price index, have contributed to high inflation.
For investors, recognizing the sources of inflation in these markets can inform better asset allocation decisions and risk management strategies.
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