Surging oil prices have sparked fears of an inflation comeback. We provide a guide to what causes inflation, how it could be managed, and what different inflationary environments mean for you and your money.

Summary:

• Inflation can be driven by supply or demand factors. Too much or too little are both bad for the economy.
  
• Central banks typically hike interest rates to tame inflation. Export-exposed countries, like Singapore, can do this through the exchange rate.
  
• Markets expect current oil supply shock to be temporary, with corresponding slowing demand eventually bringing prices – and interest rates – down.
  
• Market dislocations an opportunity for disciplined investors: higher income, undervalued assets. Keep dollar cost averaging.

1. Back to Basics: What is inflation?

Inflation describes the rise in prices across an economy. Its most obvious impact is the erosion of purchasing power: $100 today buys less than $100 a decade ago. A few factors could lead to inflation:

• Demand: Economy booms, consumers spend more, leading to price rises. This could happen when unemployment is very low and consumer confidence is high.
• Supply: A surge in “input” costs (e.g. oil, wages, freight prices) forces businesses to raise prices. Examples: 1970s oil supply shock, 2022 war in Ukraine.
• Currency weakness: Imports become more expensive as one’s currency weakens. 
• Self-fulfilling prophecy (“wage-price spiral”): Workers worried about rising prices demand higher wages (in absence of evident inflation). Cost passed on to consumers. 

A bit of inflation is good for growth, spurring consumers to spend now rather than later and lifting corporate profits. Having none at all gives you the opposite.

Most developed economies aim for roughly 2% inflation. For a developed economy, Beyond 3%, every 1 percentage point of inflation rise in a developed economy typically reduces about 0.1-0.2% off “real” GDP growth (i.e. growth after taking account of inflation), according to research by the International Monetary Fund.

2. How do countries deal with inflation?

Inflation is primarily managed through monetary policy. Most central banks, like the US Federal Reserve, use interest rates as their main lever. Higher rates cool demand by making borrowing expensive, while lower rates encourage credit to flow (when they overdo this and allow too much money in the system, however, central banks can cause inflation).

Since Singapore heavily relies on imports, the Monetary Authority of Singapore (MAS) manages inflation by controlling its exchange rate instead of domestic interest rates. To fight high inflation, the MAS allows its currency to appreciate against a basket of trading partners’ currencies. A stronger SGD makes imported food, energy, and goods cheaper, effectively cooling inflation.

History offers two paths to ending inflation:

• The hard way: Central banks engineer a hard landing. The Fed’s brutal 1980–82 rate hikes in the US crushed inflation from ~14% to ~3%. But they also caused a severe recession and unemployment north of 10%
• The “easy” way: Let supply catch up with demand. The 1990s showed that a soft landing is possible but rare. The key variable is inflation expectations: once they become “unanchored” (as in the 1970s), a second wave is almost inevitable.

A useful rule of thumb here is the “Taylor Rule”: to genuinely tighten financial conditions and cool the economy, central banks need to raise rates by roughly 1.5 percentage points for every 1 percentage point in excess of the pace of inflation. Raising rates by less simply means policy is still accommodative, just a little less so.

3. What’s the inflation outlook right now?

Markets have priced in rate hikes across most G7 economies since the outbreak of the Iran war. But history suggests this may be premature: supply-driven oil shocks tend to lift rates only briefly before growth concerns take over, pulling rates back down within six to twelve months.

This is because supply shocks simultaneously dampen growth and push up unemployment. Over time, those headwinds tend to outweigh the inflationary impulse, shifting central banks’ priority from fighting inflation to supporting the economy. Central banks may find themselves unwinding hikes sooner than expected.

Oil futures are in “backwardation” at the time of writing, meaning it’s more expensive to buy oil in the near future than in the longer run. That indicates markets expect the current disruption to be temporary. 

While it is true that the ultra-low inflation of the 2010s isn’t coming back (2% looks more like a floor than a ceiling), meaningful disinflationary forces remain. AI productivity gains are beginning to materialise, US rents are falling as record housing supply hits the market, wage growth has softened for most workers, and Chinese exporters redirecting cheap goods from the US (because of tariffs) are also bringing downward price pressures in the rest of the world. 

What does this mean for my money?

Inflation feels unsettling right now because the usual defences aren’t working, with the “safety” of bonds and gold seemingly fading. The lesson from history is reassuring: supply shocks eventually resolve, either because demand cools and rates fall, or because supply constraints ease and prices normalise. Either way, markets eventually find a way to recover.

For the disciplined long-term investor, market dislocations can provide significant opportunities – here’s how you can take advantage of them on Syfe:

• Anchor With Income: Don’t give up on the income opportunity. Bond yields (which rise when bond prices fall) are more attractive now. Our Income+ and REITs+ portfolios are offering payouts in the 5% range.
  
• Strengthen Your Core: Our Core portfolios contain global equities, bonds, and commodities for diversification, helping you stay invested for long-term growth.
  
• Get (Smart) Active: Gain an edge with our new Equity Alpha, powered by JPMorgan Asset Management, a smart active strategy designed for the current high “dispersion” market, with research-enabled stock selection at scale.
  
• Hold (Just Enough) Cash: Stay flexible, preserve capital, and be ready to deploy when opportunities appear with our Cash+ solutions.
  
• Finally, discipline matters: Keep dollar cost averaging (DCA), and use enhanced DCA – investing more than usual in significant sell-offs – to capture more of the opportunity. Start today with the Auto Invest function on the Syfe app.