Building inflation-resilient portfolios: a practitioner’s guide

It has been over three decades since the ‘Great Moderation’ of the 1990s began a secular decline in inflation outcomes, macroeconomic volatility, and bountiful financial market returns. Unfortunately, it is self-evident that we are no longer living in this idyllic world! Over the five years to June 2026, inflation in Australia as measured by the Australian Bureau of Statistics’ (ABS) headline consumer price index (CPI) has averaged 4.4 per cent per annum, a far cry above its 1990 to 2020 average of 2.6 per cent per annum.

We wrote extensively about the underlying global secular shifts that have been driving this step-change higher in inflation outcomes and volatility in our October 2023 Observation piece ‘Asset Allocation in a Changing World’. In short, these include (i) our increasingly multipolar world, (ii) intensifying populist and nationalist politics and policies, (iii) ageing demographics, (iv) the challenges of navigating climate change and the global energy transition, and (v) the rollout of new technologies including artificial intelligence (AI). In this Observation piece, we seek to help investors address one of today’s foundational investment strategy challenges: how to build inflation-resilient portfolios. We start by laying out a practitioner’s framework for considering the key drivers and characteristics of inflation, including why we need it in the first place. We then evaluate how investors can pivot their portfolios to build resilience against various flavours of inflation as needed, including a surprisingly overlooked but staple ingredient that most astute investors already have at their disposal!

A primer on inflation

The list of academic treatises on inflation is near-endless, with veritable libraries full of musings about its roots, macro- and micro-economic mechanisms, policy interactions, and financial market implications. Some of the economics profession’s most celebrated minds, including Irving Fisher, John Maynard Keynes, Milton Friedman, Edmund Phelps, Robert Lucas, James Tobin, and Stanley Fischer have put pen to paper to advance our theoretical understanding of this deceptively complex yet incredibly impactful concept. We encourage readers who are intrigued to delve deeper into this challenging but rich body of work (or get your preferred AI assistant to do so).

For the purposes of this Observation piece, we will limit our excursions into the academic literature. Instead, we lay out a practitioner’s guide to the key drivers and characteristics of inflation, insofar as they impact on our thinking when we construct portfolios and consider investment opportunities. We begin with a simple definition of inflation and why we need it.

What is inflation, why do we need it, and why should we dread deflation and hyperinflation?

At its broadest level, inflation measures the changes in the general level of prices for goods and services across an economy over time. Inflation can be positive or negative, and each participant in the economy ultimately experiences inflation in their own unique way based on the mix of goods and services that they consume. For example, a family with a home mortgage and children attending a private school consumes a different set of goods and services to a young couple with a pet but no offspring, or a corporation involved in importing and selling automobiles. 

To give all economic participants and institutions a level playing field of information and help them make thoughtful decisions, government statistics agencies, including our own ABS, expend immense effort to compile the movement of prices across the entire economy. These are aggregated and summarised into indices, including the headline CPI we referenced earlier.

The current accepted economic best practice is to manage inflation so that it is moderately positive over time. Most major central banks choose to effect this by managing a chosen inflation index (typically one that tracks ‘core’, or less volatile prices) at around a two per cent pace, and this includes our own Reserve Bank of Australia (RBA), which targets a range of two per cent to three per cent per annum over the medium term.

Why do we believe that a moderately positive level of inflation is the best path for the economy?

• It encourages economic activity. Moderate inflation slowly erodes the purchasing power (or real value) of cash, as the same dollar buys incrementally less over time. This encourages consumers and businesses to spend money and/or invest in productive assets or opportunities rather than hoarding cash. Economics 101 tells us that one person’s spending is another person’s income, so this ‘background’ pressure to spend helps encourage economic activity and growth. 
• It helps manage debt burdens. Just as moderate inflation erodes the real value of cash, it also slowly reduces the real value of nominal debts across the economy. A simple example is a residential mortgage: the amount borrowed is fixed once the purchase price of the home is confirmed. Meanwhile, the borrower’s wages tend to increase over time as productivity improves, supporting growth in real wages and household incomes. This gradually reduces the burden of mortgage repayments relative to income. Moderate inflation can support this cycle by facilitating growth in nominal incomes. Historically, this combination of economic growth, rising productivity (and real wages) and moderate inflation has been one of the key ways economies have successfully ‘grown out of’ their debt burdens.
• It accounts for underlying economic divergences and measurement errors. Inflation indices like the CPI track a broad range of goods and services across the economy. At various points in time, some of these components may experience significant price rises or price declines. For example, insurance costs might rise sharply after a natural disaster. Conversely, prices for clothing and apparel have generally fallen over the past few decades due to globalisation. Adopting a moderately positive target at the index level allows for flex in these various underlying sectors of the economy. It also creates a margin to allow for errors and vagaries in the actual measurement of inflation, which as one can imagine is an immense and imprecise undertaking across an entire economy.
• It reduces the threat of deflation. While it might seem a good idea for prices to fall over time, deflation is one of the most insidious states for an economy and one of the most difficult to escape. In direct contrast to the points above, deflation destroys economic incentives to spend or invest. After all, why buy a loaf of bread today if it will be cheaper tomorrow? Regrettably, this decision puts the baker at a loss. Fearful of this, they might postpone expanding their bakery and may even have to lay off some workers. This negative spiral compounds, sapping consumption, business investment, economic activity, and ultimately damaging employment and societal prosperity. This example is no thought experiment either! The Great Depression of the 1930s gave us a terrifying proof case of these dynamics in action across the globe over an agonisingly long and painful decade. Japan’s two decades of deflation from the late 1990s is a more modern example. Deflation also increases the real value of debt, which magnifies the burdens on debtors, who must now repay fixed nominal debts with income and assets that are falling in price. This may lead to forced sales of assets, further fuelling the downward price spiral. Irving Fisher wrote extensively about this dynamic, terming it debt-deflation and positing it as a key mechanism that worsened the Great Depression. Finally, a deflationary environment reduces the levers that governments and policymakers have to support the economy. Interest rates can only be lowered so much (the post-2008 experiment with negative interest rates proving their reduced efficacy below the zero bound). Government debt burdens are similarly magnified by deflation, and poor economy-wide sentiment reduces the impact of modest stimulus programs. 

We round out our overview of inflation with one more state that can be even more catastrophic than deflation. Hyperinflation is an extreme form of inflation, generally brought on by a loss of faith in the government and economic policymakers of the day. It is characterised by hyperbolic price rises (exceeding 50 per cent per month) that render a currency useless as a practical store of value and a medium of exchange. It is usually driven by uncontrolled government deficits, leading to excessive money printing and debasement of a nation’s currency, breaking society’s confidence in that currency and ultimately the sovereign printing it. Famous examples include Weimar Germany (1921 to 1923), Hungary (1945 to 1946), and Zimbabwe (2007 to 2009). Hyperinflation is considered a rarer economic state than deflation, but its consequences can be far more dire: it can and has led to major political turmoil and regime change, with Weimar Germany’s case being the most extreme example that led to the rise of Adolf Hitler.

To summarise, the ideal level of inflation for an economy is a bit like Goldilocks’ preferred porridge: neither too hot nor too cold, but running at a level that is enough to encourage investment and economic activity without negatively impacting living standards.

Key drivers of inflation

Below we lay out our framework for considering the key drivers of inflation. It considers two broad, interdependent and mutually-influencing dimensions: fundamental drivers and policy drivers, both of which can act over cyclical and secular timeframes and both of which interact with and influence each other.

The fundamental drivers of inflation arise endogenously from the behaviour of various economic participants. These answer the question, What is happening in the real economy that is causing prices to move?

Demand-pull inflation arises as the demand for goods and services fluctuates. Examples include a low unemployment and high wage growth environment that encourages stronger consumer spending, raising demand relative to supply and putting upward pressure on consumer goods and services prices. The AI capital expenditure (capex) boom is another example of strong demand pushing up prices for key components like semiconductors and memory chips. This can work in the reverse too – an economic recession that lowers employment and consumer spending will reduce demand for goods and services and impart downward pressure on prices.

Cost-push inflation arises as changes in the supply side of the economy affect the prices of goods and services. For example, an immigration boom might boost the supply of labour, putting downward pressure on wages. A more extreme inverse of this is a supply shock, akin to the 1970s Arab oil embargo or the 2026 US-Iran conflict, which suddenly reduced the supply of crude oil to the global market, imparting upward pressure on prices. Weather events – droughts and floods – are another example of supply shocks that can drive cost-push inflation.

Demography and labour market dynamics capture the longer-term influences on the workforce and wages growth, incorporating structural influences such as worker and union bargaining power, labour-force participation, immigration, and population ageing. Typically, societies with high union bargaining power, low labour-force participation, and low immigration tend to have a smaller labour force and higher relative labour costs, which feed into inflation, over the long term. 

Technological change is often structurally disinflationary as it raises productivity, substitutes for labour (reducing wage pressures), and generally improves economic efficiency or expands societal living standards. That said, the transition to new technologies can have a more volatile cyclical impact, as the capex required to roll them out can exert demand-pull pressures.

Policy drivers of inflation 

The actions of policymakers also influence inflation, whether deliberately or unintentionally.

Fiscal policy acts as a government-driven demand-pull factor: stimulatory fiscal policy increases aggregate demand and can impart upward price pressures. This can be a godsend during a recession as it supports economic recovery, and in targeted forms (eg infrastructure spend or targeted relief) can also buoy specific sectors. If poorly designed or if deployed into an economy that is already running at full capacity, however, fiscal stimulus can exacerbate demand-pull inflation, creating a potential headache for the second key cyclical policy pillar: monetary policy.

Monetary policy encompasses the actions of central banks, who attempt to manage inflation to their stated targets by influencing borrowing costs, credit availability, and exchange rates. Their primary toolkit for doing so is via the policy rate, which in Australia is the RBA’s cash rate target. Central banks seek to lower inflation by raising interest rates, which increases borrowing costs and discourages spending. They also seek to promote higher inflation by lowering interest rates or engaging in other behaviour such as quantitative easing (QE) to encourage spending and investment. 

Secular policy considers the structural set of fiscal, administrative, regulatory, tax, and other key policy settings of an economy. These include wages and labour policies, tariffs, tax policy, competition policy, and others, and can influence an economy’s long-run price levels, inflation rates, and supply capacity. For example, a closed economy with high import duties, high minimum wages, and an inflexible labour market may encounter higher overall price levels, more volatile inflation outcomes, and stickier inflation than a more open economy with more flexible secular policies.

Long-term inflation expectations measure an economy’s structural inflation regime, or the ‘background’ level of inflation that most economic participants expect over time. This typically maps to the central bank’s stated target rate of inflation and the ‘economic ideal’ of moderately positive inflation that we discussed previously. In Australia’s case, it is two to three per cent per annum over the medium term. These expectations may fluctuate over time, but so long as they remain broadly anchored, households and businesses can weather cyclical shocks to inflation.

Policymaker credibility is a direct counterpart to long-term inflation expectations. If economic participants lose confidence that policymakers are committed to anchoring long-term inflation, these expectations can de-anchor, leading to a sinister inflationary cycle that can ultimately lead to hyperinflation. Defending this credibility is critical to an economy’s long-term viability, and major policymakers have historically shown significant commitment to this. Paul Volcker’s aggressive rate hikes in the 1980s and the global interest rate tightening cycle of 2022 are forceful examples of monetary policymakers stepping in to defend their credibility and re-anchor inflation expectations.

Complex, reflexive, and intertemporal interactions

Would that life could be so simple and we could consider and invest against each of these inflation drivers separately and exclusively! Unfortunately, reality is much more complicated, and there are complex, reflexive, and intertemporal relations across and between all the fundamental and policy drivers we have discussed. 

For example, an energy supply shock (such as the one sparked by the 2026 US-Iran conflict) might raise fuel and electricity prices. This may force businesses to pass on higher costs to customers. In response, workers demand higher wages growth to make up for this loss of purchasing power. Such a price-wage spiral (as former RBA Governor Lowe termed it in 2022) may lead to broader price pressures across the economy, lifting near-term and long-term inflation expectations. The central bank is then faced with a challenge: adopt a hawkish stance and tighten policy to defend their credibility and re-anchor inflation expectations, or risk an inflationary feedback loop that requires more drastic action down the road. Throughout all this, fiscal policymakers may also intervene – they could cut government spending to help reduce the upward pressure on prices, or (more likely) they might ease policy via cost-of-living handouts, further increasing aggregate demand (adding to inflationary pressure).

LGT Wealth Management’s practical guide to inflation resilience

Armed with this comprehensive theoretical overview of inflation and an appreciation of its complex and mutually influencing drivers, how might an investor go about building inflation resilience into their portfolio? We lay out LGT Wealth Management’s four-step practical guide to inflation resilience below:

1. Understand how each driver manifests in inflation outcomes and interacts with others.
2. Consider the asset classes or investments that are most sensitive or correlated to each driver.
3. Probabilistically assess the cyclical and secular drivers to identify any critical areas or catalysts to monitor.
4. In the context of our broader secular and cyclical outlooks, assess current portfolios to reaffirm positions that are appropriately inflation-resilient and identify potential areas of vulnerability. If required, pivot portfolios to address these vulnerabilities.

Steps 1-2: Understanding the linkages between inflation drivers and asset classes

The table below summarises our views on steps 1 and 2 of our process, where we consider the various interactions across the key cyclical and secular drivers of inflation, as well as the most correlated asset classes based on our historical experience and analysis.

Source: LGT Wealth Management

Scanning the table above gives us three broad observations:

1. Equities and real assets can provide resilience against demand-pull, policy-driven, and secular inflation pressures.
2. Fixed income can be an appropriate investment once policymakers step in to bring inflation back under control.
3. Commodities and inflation-linked bonds have generally limited use cases and are less practical long-term solutions.

The third observation may be the most surprising given recent headlines around oil prices. Indeed, most investors would expect that inflation-linked bonds, by nature of their name, should provide the most comprehensive protection from inflation. Mechanically, they do indeed provide a coupon linked to inflation outcomes and can protect in the near-term against fundamental drivers like demand-pull and cost-push inflation. However, this ignores the interaction of these drivers with policy response. As we saw in 2022, the eventual hawkish response of central banks to post-COVID inflation led to a sharp rise in real yields, directly reducing inflation-linked bond prices. This meant that, while inflation-linked bonds provided some protection in 2021 and early 2022, they suffered significant losses over the remainder of the year, despite still-hot inflation outcomes.

Some investors might also be surprised to see plain old equity exposure listed there as an asset class with linkages to most of the inflation drivers, particularly against secular inflation. We wrote about this phenomenon in our July 2025 Observation piece ‘The Future of Money?’. In our view, equity risk (whether public or private) exposure has been by far the most effective way to build long-term real wealth and protect against inflation and currency debasement. Three key reasons back this – dividend income, the linkage of corporate revenues to inflation over time, and most importantly exposure to human ingenuity and innovation! 

These reasons are why we maintain a meaningful exposure to equity risk through public, private, and alternative markets across our client portfolios (and within the context of our secular outlook, where inflation remains a key feature of a multipolar and populist environment). It should also hopefully give some comfort! Most growth-oriented multi-asset portfolios should already have a sizeable long-term hedge against inflation and currency debasement via their pre-existing equity risk exposures.

Steps 3-4: LGT’s current views on inflation resilience

We bring our framework to its practical culmination below, laying out our current assessments of the key inflation drivers across the US and Australia, and where we are pivoting client portfolios as a result, on a cyclical and secular horizon. 

Source: LGT Wealth Management. 

Based on these assessments, we see inflation as being more of a challenge cyclically and secularly in Australia than the US, primarily driven by our lower energy security, higher wage environment, less flexible labour market, and lower productivity growth. That said, we are not concerned about an imminent risk of a runaway inflationary spiral, and we see inflation outcomes likely averaging 0.5 to 1 per cent above central bank targets in the US and Australia over the next five years. An uncomfortable experience, but by no means an imminent societal or existential concern!

Nevertheless, this is still a stickier inflation backdrop that requires portfolio attention. As our concerns lie more around the secular drivers of inflation, we are generally eschewing a knee-jerk move into commodities and inflation-linked bonds, and instead pivoting client portfolios more towards equities and real assets to build secular inflation resilience. Within this, we are also seeking ‘common ground’ opportunities that also straddle our other key secular views: namely our multipolar outlook and bottleneck thematics including AI enablers, AI adopters, energy resilience, and defence and infrastructure.

On a more cyclical horizon, we are also noting the hawkish response of central banks to the US-Iran energy shock, and maintain our broad view that policymakers will aggressively defend their credibility by hiking interest rates in the face of inflation. In that regard, nominal fixed income is beginning to look more attractive given the rise in yields over the past year.