'Greenflationary' expectations revisited

Despite signs that inflation may have peaked in Europe, investors are naturally fearful that another bout may be lurking around the corner.

Expectations over the future direction of inflation are pivotal in determining investor allocation between various assets - cash, bonds, equities, currencies, commodities, etc. Nevertheless, asset markets tend to be at their most vulnerable when there is a surprise rise in inflation.

Unexpected inflation often leads to lower expected future cash flows for business, particularly as it is usually associated with economic weakness. Unexpected inflation also typically leads to higher risk premiums which serve to reduce equity valuations. Unexpected inflation, especially when it is high and volatile is a potent source of economic uncertainty.

For some investors, government policy focused on meeting net zero, particularly rising carbon prices is likely to be the source of the next rise in inflation (see 'Greenflationary' expectations).

So should investors be concerned?