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Inflation has been scarcely heard about for two decades. Ronald Reagan’s attempt to bring it down to street level – “inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hitman” – was looking very dated. Loose monetary policy was not the topic of choice at dinner parties.

But inflation has hardly left the headlines over the last month. The Federal Reserve, the European Central Bank and the Bank of England have taken turns issuing statements that have variously been read by the markets as “hawkish” or “dovish” – signalling hard-line or more conciliatory policies respectively.

The result has been high volatility in interest-rate futures and bond yields, which move in correlation with interest rates.

The most dramatic example was the ECB’s announcement on 5 June that a quarter percentage-point rate increase in July was “possible”, which provoked a sharp sell-off of government bonds across the eurozone. “The only surprise was that the ECB statement came as such a surprise,” was the verdict of William De Vijlder, global chief investment officer at Fortis Investments, implying markets had not been taking inflationary pressures seriously enough.

But ECB officials then moved to reassure markets that they had not been “talking about a series of rate increases”. Mervyn King, governor of the Bank of England, has similarly promised a tough stance on inflation while carefully avoiding suggestions he would raise interest rates. Central bankers understandably want to keep their options open.

The overall message, however, is clear - inflation is to be taken seriously. “Central banks have done a reasonable job at making clear that they perceive there to be an inflation risk,” says Richard Urwin, chief economist at BlackRock. This marks a shift away from widespread assumptions in March and April, when bond yield curves were pricing in rate cuts, that the risks to growth had the upper hand.

What, then, does this mean for investors? How can asset-allocation strategies adapt to the inflationary threat?

The basic rule is that high inflation is necessarily bad for investors. Inflation eats away at value, so that £100 tomorrow buys less than £100 now. This works in favour of debtors – their mortgage is worth less than it used to – and to the detriment of creditors, whose assets have financed those shrinking debts.

Within the big picture, there are, of course, nuances. Some assets will be affected more negatively than others. Asset allocators have the job of deciding which.

Fixed income is the most obvious victim. Mr Jones’s five-year government bond, which he bought for £100, earns him a fixed coupon of £5 a year. If inflation is 6 per cent for that period, he will require £133.82 (£100 multiplied by 6 per cent to the power of five) to buy the same basket of goods at maturity that used to cost £100. But he has only earned £25 in coupons to compensate for the increase - he has lost money.

This is why traded bond prices fall when expected inflation increases. Yields, meanwhile, rise in proportion so that they exceed the inflation rate. Had Mr Jones known inflation would be 6 per cent, he would have demanded a coupon of at least £6 on his £100 principle. Alternatively, he might have paid only £83.33 (£5 divided by 6 per cent) for his £5 in fixed income.

Asset allocators are therefore in agreement that gilts are a bad investment in the current climate. Midas Capital Partners is one example. “We are holding minimal levels of gilts, and those we have held have been of short duration,” says Simon Edwards, chief executive. “The twin problems of rising inflation and deteriorating government finances are making us very bearish. There have been marked signs of deterioration in the markets over the last six to eight weeks, and that is likely to continue.”

The relationship between inflation and equities is less clear-cut, as returns are not fixed. Inflation should have the same effect on a company’s cashflows as it had on Mr Jones’ £5 coupon, which should lead to a stock-price devaluation parallel to the fall in value of the £100 principle to £83. But if the company is able to pass on cost increases to clients, any inflation will be reflected in the profits. Some people therefore consider equities "inflation-proof".

But this does not hold true of the current environment. Rob Burnett, fund manager at Neptune Investment Management, recently told Investment Adviser that if oil prices continued to rise, equities would remain depressed, while if they “corrected”, equities would rebound. “It really is as binary as that,” he said. Not everyone would go so far as to suggest commodity and share prices are locked in inverse correlation. But no one is suggesting the stock market is inflation-proof in the current environment.

“When inflation is solely driven by increased commodity prices, economies that use more oil than they produce are going to suffer,” says Mr Urwin. This is as true for the UK as it is for the emerging giants China and India. In Europe, where central banks have a single mandate to contain inflation, the pressure on profits from higher oil costs is then compounded by monetary tightening.

Where, then, are the “safe havens” for investors in the current environment? The obvious answer is, any asset linked to inflation is safe. Economists call these “real assets”. Chris Jeffery, economist at Fortis Investments, notes inflation-linked bonds – on which returns are dependent on a price index such as RPI – as the cleanest example.

Commodities are the most popular inflation-linked asset, however. By their very nature, commodities form part of the price index that is the barometer of inflation. The problem – now well documented – is that, as investors flock into the safe haven of commodities, the price index leaps up further, creating a vicious inflationary spiral.

But savers can take heart. It is not yet certain that inflation – the grim reaper of investment – is here to stay. There is little evidence so far that the commodity bull has led to salary increases, which economists fear above all else. “Wages are 60-70 per cent of the cost structure,” Mr Jeffery points out. “We are not yet seeing the wage-price spiral of the '70s.”

He also expects the economy to rally to the cause. “We are relatively sanguine, as the slowdown in train should act to cap concerns about inflation in the medium term.” Fortis’ optimism echoes Mervyn King’s letter to the chancellor two weeks ago: “In the absence of further unexpected increases in oil and commodity prices, inflation should peak around the end of the year and begin to fall back to the 2 per cent target,” he wrote.

But Mr Urwin describes the assumption of stable commodity prices as “heroic”. He does not offer his own projections. “I hate the phrase”, he says, “but the level of uncertainty about the future is greater than usual.”

Stephen Wilmot is a features writer at Investment Adviser