How big a threat is inflation?

This note examines inflation which seems to be rising everywhere and has supplanted the credit crunch as the main worry for investors. The key points are as follows:

• Food and energy are the main drivers of the rise in inflation right now, although it is Australia and parts of Asia.
• Over the next few months, inflation and stagflation worries will add to the volatile ride for financial assets.
• However, our assessment is that inflation will decline as growth slows and as oil prices fall in the next six months. As a result, market expectations of interest rate hikes are overblown. Signs of lower inflation and lower bond yields should also help share markets to rebound from later this year.
• We remain of the view that the Reserve Bank of Australia has done enough to ensure that inflation will head back to target in a reasonable timeframe. If anything it has probably done too much. The slump in demand indicators suggests that the economy has reached a tipping point and that the negative impact of higher interest rates and high petrol prices on demand in the economy are now overwhelming the positive impact of high commodity prices and tax cuts. The next move in Australian interest rates will likely be a cut.

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About Oliver's Insights

Oliver's Insights is a regular update from Dr Shane Oliver, Head of Investment Strategy & Chief Economist, AMP Capital Investors.

In Oliver's Insights, Dr Shane Oliver explores the latest issues regarding financial markets and the economy.

Who is Dr Shane Oliver?

Dr Shane Oliver joined AMP in 1984 as a research officer and in 1994 became AMP's Chief Economist. He now plays a major role in determining AMP Capital Investors investment strategy and asset allocation. He also provides economic forecasts and analysis to the asset class portfolio managers. As Chief Economist, he maintains a media profile for AMP Capital Investors on economic and investment market issues.