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The inflation psychology is kicking in

  • Inflationary pressures are now everywhere: since the start of the year, inflation data has exceeded the expectations of many analysts and commentators. Annual CPI readings reached their highest level in decades in both developed (DM) and emerging markets (EM), with some variation across countries. Though fuelled by the conflict in Ukraine, which has caused disruptions across energy and commodities markets, rapid price increases are now sustained by a deeper, intrinsically psychological factor.
  • Inflation and psychology: the role of collective long- and short-term memory, public reactions, and the propagation of narratives across economic agents and through the media ensures that the self-fulfilling prophecy of inflation is ultimately realised. This is a process of memory awakening and is part of the wider ‘road back to the ‘70s’ narrative.
  • Role of policymakers: as policymakers are being pressed hard for protection and compensation, inflation leads to more fiscal accommodation rather than less, which ultimately causes further inflation. Monetary policy has fallen behind the curve and authorities are faced with the dilemma of fighting inflation without stifling growth.
  • Investment consequences: investors are looking at real returns as the new mantra for this decade. Portfolio construction that targets real rather than nominal returns should include real and alternative assets, high dividend stocks and flexible fixed income strategies that can adapt to higher rates.

After a decade of central banks struggling to bring inflation up to target, the start of 2022 has been characterised by a shift in the inflationary environment worldwide. US inflation is at its highest level in over 40 years, with other DM trailing close behind. Eurozone annual inflation reached 7.5% in March, up from 5.9% in February and 5.1% at the start of the year. The average DM CPI at end-March was 5.6% YoY and 7.2% in EM, signalling the start of a new inflationary era. Within this context, market attention has shifted to uncovering the psychological mechanisms which underpin inflation and ensure its self-fulfilling prophecies come to pass, as the expectation of higher prices in the future reinforces the inflationary narrative. In this interview, Pascal Blanqué uncovers some of these mechanisms and explores the link between inflation and psychology.

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