The "I-word" could be back as a worry for central bankers and investors next year, the wealth management house said.

After being seemingly dead for years, the old beast of inflation could return to haunt investors and policymakers alike towards the latter stages of 2018 and central banks may find themselves to stay on top of the challenge, warns Lombard Odier Investment Managers.

Although some citizens might contest the idea that forms of inflation have been muted (rising asset prices, notably residential property), inflation has generally been thought of as a minor problem since 2008, with thoughts often more dominated by fear of deflation – a general drop in the price level. 

But after years of central bank quantitative easing and an increase in economic growth, plus regulatory increases, inflation may be back, the Geneva-headquartered firm said in a note, authored by Salman Ahmed, chief investment strategist.

“On the inflation risks front, using the array of indicators we watch, the current healthy mix of strong growth/low inflation appears set to continue in coming months. However, our fear is that the old model of inflation (inflation rises non-linearly as capacity constraints increase) is not dead and could prove to be the spanner in the works. If that is the case, in the second half of the year policy makers could suddenly find themselves woefully behind the curve, with inflation rising and asset prices significantly overvalued,” Ahmed said.  

“Despite the excitement around disruptive technologies, the rise of crypto currencies, Artificial Intelligence and robotics, we expect good old central banks with their printing presses to remain the most important determinant of key risk asset prices next year. As the era of quantitative easing (QE) by central banks gradually draws to a close in the current business cycle, the impact of tightening/less accommodative monetary policy will depend on what made QE work in the first place,” he continued.

Ahmed said that central banks have become smarter at how they communicate their policy views to the markets. Unlike the market volatility that was triggered in 2013 when the US Fed signalled it was tapering – or winding down – QE the Fed and the European Central Bank have managed to signal their policy plans more recently with far less market turmoil.

“With inflation remaining comfortably below target levels, central banks have not felt an urgent need to sharply cut back on their monetary policy stimulus measures. However, the long-term risks associated with a sustained period of easy monetary policy are in evidence in high valuations across a variety of assets, especially government bonds, which have become more of a policy tool than an asset class. It is becoming harder for central banks to focus solely on inflation (low and stubbornly stable) and ignore asset prices (broadly high),” he added.