Inflation is biting hard, and it will eat more and more as time wears on!

Overall, consumer prices (CPI) increased by 0.8 percent in July. It has risen at an extraordinary 10.6 percent rate over the last quarter, compared with a 5.6 percent rate over the last year.

A 4 percent jump in energy prices was the biggest factor pushing up the core index, but food prices also rose by 0.9 percent.

Producer prices (PPI) surged, too, in July, the fastest in 27 years. Wholesale prices are up 1.2 percent, double what economists had expected.

Given that energy and food costs remain high throughout the production pipeline, as highlighted by PPI, upside pressures should persist over the summer months. Headline CPI likely to remain above 5 percent in the short term, with core CPI to rise.

Despite upward pressure stemming from import prices, apparel prices remain in deflation. Collapsing auto sales and a weak housing market should continue to ensure steady deflation in these items.

Energy is still the biggest contributor to headline inflation. Food and fertilizers ran second.

According to Michigan Consumer Sentiment Survey, median 1-year inflation expectations fell to 5.1% in late July from 5.3% in early July, highest level since 1981.

Five- to 10-year inflation expectations are down to 3.2% from 3.4%, their highest level since 1996.

Goldman Sachs sees CPI peaking at 5.5 percent to 5.4 percent year-on-year in August or September if oil prices remain in $100 to $135 a barrel range. CPI could peak at 6.5 percent if an oil supply shock occurs (such as a hurricane knocking out supply).

I personally believe we will see higher inflation going into 2009.

As part of a diversified investment portfolio I would therefore consider putting some capital in serious, inflation-linked yet easy, liquid investments.

Today, in this context, I like JPMorgan Chase floating rate notes linked to the Consumer Price Index due September 2, 2011, which is in fact three year term with monthly interest payments.

Using the CPI number of Aug. 14th we would make 7 percent. This is very good for an investment return in U.S. dollars that is as good as cash.

Getting out these bonds at a good price should always be easy. JPMorgan Chase is a superior U.S. bank. I wouldn’t be so confident with the weaker ones, which may fail, merge or be acquired.

Today, however, I would certainly not consider investing in Treasury TIPS (Treasury Inflation-Protected Securities).

On Aug. 15, the five year real yield was 1.16 percent, which is, of course, a real negative yield.