What is Inflation?

What is Inflation?

There has been a lot of talk about the inflation rate in Australia recently, especially after the Reserve Bank to raised interest rates, which, for many people seems counter-intuitive. Inflation is a complex beast and understanding the impact of inflation can help you make wise financial decisions in these unsettled times. So what is inflation is and what impact might it have?

A Definition

Simply put, Inflation is a decrease in the purchasing power of money, reflected in a general increase in the prices of goods and services in an economy.[i]

As we mentioned in our recent article Inflation and the Cash Rate – Behind the RBA Decision, the Australian Reserve Bank likes to keep our inflation rate at between 2 and 3%. The reason for this is the need to balance growth in the economy.

What Causes Inflation?

Inflation can be caused by a whole raft of factors. However, increased demand, low borrowing rates, high levels of employment, and rising wages are all contributors. Right now our inflation rate is exacerbated by supply chain issues and global fossil fuel policies.

The Impact of Inflation

The most obvious impact of inflation is a rise in prices. In their efforts to slow the economy, the RBA have raised cash rates, which leaves mortgage holders with less disposable income, leading them to spend less. Less demand equals lower prices theoretically.

However, when prices rise, there is increased pressure on wages, as can be seen by the recent increase of 5.2% in the minimum wage. Higher wages lead to higher costs. Lead to higher prices.

You can see why inflation is often referred to as an ‘inflationary spiral’.

 Global Inflation

These days, even if all is well in the Australian economy, the economic health of our trading partners can have a negative effect on our own inflation rate. So when inflation is running high around the world the cost of goods imported into Australia goes up. Inflation also decreases currency value, weakening it relative to other currencies.

In fact, while we are all, rightly, concerned about an inflation rate of 5.2%, we are in a better position than many economies. Currently, the inflation rate is 6.8% in Canada, 8.6% in the USA and 9% in the UK. And spare a thought for Turkey, where their inflation rate is an eye-watering 73.5%.[ii]

Impact on Investors

Increasing inflation often leads to volatility in the stock market. However, it also provides better rates through risk free investments like term deposits. This is a time when it’s important to get professional advice on where, when and how to be managing your investments.

Impact on Housing Prices

Increased cash rates generally lead to a reduction in housing prices, which is great news for first home buyers. It’s also not necessarily bad news for those already in the market. Yes, the value of your house may well decrease, but if you are looking to downsize, upsize or just move somewhere else, the value of the houses you will be looking at will have similarly decreased. As long as you are buying and selling in the same market price changes should have little effect.

What You Can Do

There are a few things you can do to protect yourself during inflationary periods.

1. Take a careful look at your spending habits and make sure you are not leaking money unnecessarily.
2. Take a good look at your mortgage and make sure you are getting the best deal available. This may also be a good time to consolidate if you have personal loan or credit card debts.
3. Fix all or part of your mortgage rate to protect against further increases.
4. Watch for good rates on safe savings options.
5. Consider your risk profile and make sure you are happy with your exposure. Now is probably the time to shore up on ‘blue chip’ investments and companies with strong balance sheets, rather than riskier options.

If the thought of rising inflation leaves you feeling a little unsettled, Manly Financial Service have the expertise to review your financial position and help ensure you are able to meet your financial obligations as well as identifying strategies to help you outpace inflation. Give us a call on (02) 9976 3388 or contact us via the below link.

Interested in knowing more?

References:
[I] https://www.imf.org/external/pubs/ft/fandd/basics/30-inflation.htm
[ii] https://tradingeconomics.com/country-list/inflation-rate