Australia's Inflation Surge!

What the 4% Inflation rate means for your wallet!

Australia's inflation rate has recently jumped to 4% in May, marking a notable increase from 3.6% in April. This upward trajectory has sparked concerns among different groups:

• Businesses and policymakers are monitoring the rising inflation, anticipating potential economic hurdles.

• Investors are feeling uneasy as the inflation rate continues to climb, impacting market dynamics.

• The general population in Australia is bracing for the likelihood of the Reserve Bank of Australia raising cash rates in response to inflation.

Source: Australian Bureau of Statistics

The latest statistics from the Australian Bureau of Statistics suggest that inflation has grown to 4% from May 2023 to May 2024, driven by a 7.4% increase in rents, 6.5% increase in electricity costs, and a 6.7% increase in prices for alcohol and tobacco. These were only some of the major categories that contributed to this increased economic pressure, adding to the uncertainties that already permeate the Australian economic outlook.

But why is this such a big deal?

Milton Friedman, a renowned economist, once famously said "inflation is always and everywhere a monetary phenomenon." This reveals why monetary policy in the past year has been so constrictive - the best way to tackle economics is changing the interest rate. Let's learn why this is the case so you can be experts in this!

Insight of the Day The Reserve Bank of Australia (RBA) is in charge of conducting the Monetary Policy. This policy aims to affect the cash rate, which have a direct relationship with the commercial interest rates that Australian households and businesses receive. Put simply, a higher cash rate will mean higher interest rates. Since Australia's inflation rate peaked at 7.8% in the last quarter of 2022, the RBA has increased their cash rates rapidly, from 3.10% (December 2022) to 3.85% (May 2023) to 4.35% (November 2023). Why? Higher cash rates cause higher interest rates which constrict our ability to borrow from the bank. At higher interest rates, you and I have to pay more in loan repayments, which disincentivise us as individuals or businesses to borrow any money. Without borrowing, a household spends less money and a business invests less money, reflecting a lower demand in the economy. Since people are not buying as much anymore, businesses avoid increasing their prices to make sure they don't lose their customers - and boom! Inflation stops growing as fast. This is not the only way though - what if you have an existing loan? Well, approximately 70% of Australians have a variable interest rate loan, which means their interest rate changes as the market interest rate changes. This is in comparison to 15% in the United Kingdom and only 5% in the United States, where the 'fixed-rate' terms are 5 years and 30 years respectively. In Australia, the average Australian can only secure a fixed-rate loan for two to three years! Why is this relevant? Because as Australians, we are much more vulnerable to interest rate changes. When the RBA increased cash rate and interest rates, a majority of Australian households had to pay more on their existing mortgages. The standard mortgage of about $600,000 therefore attracted a $1,200 increase in monthly repayments on average when comparing average interest rates from 2022 to 2024. This means both households and businesses have less money to go and consume or invest, leaving less demand and thus slowing down inflation.

This justifies why your mortgage repayments have increased, and caused stress amongst many Australian households. But what now?

The RBA's Monetary Policy Decision meeting is scheduled for 6 August, just about a month away. With this increase in inflation creeping in, the prospects of them increasing the cash rate has also increased. In fact, 36% of investors are betting on a cash rate increase, up from only 13% before this inflation upsurge was announced. Now, we must keep in mind that there is more information yet to come. 31st July is the date when the recent quarter's inflation rate statistics will be measured and announced, which are far more accurate than the monthly indicator the Australian Bureau of Statistics has used. Regardless, the trends suggest that there is significant pressure on the RBA to increase the cash rate, which Michelle Bullock has announced "it (RBA) will do what is necessary to achieve that outcome."

Where is this pressure coming from?

Well, many say that the recent Federal Budget is adding pressure on the RBA to increase the cash rate. Treasurer Jim Chalmers and Prime Minister Anthony Albanese have created a Federal Budget that predicts to spend $28.3 billion more than the government earns. This includes provisions for a $300 rebate on household energy bills, a revamped tax cut of approximately $1,888 per Australian taxpayer on average and a 10% increase in Commonwealth Rent Assistance program. Whilst these are great for the social-minded, and of course a strong build up to next year's elections, many are questioning the budget's economic functions!

So whilst these measures will help to ease the financial burden on households, and increase the historically low rates of economic growth, they also risk fueling further demand to potentially drive inflation higher. Economists seem to have mixed opinions about this - some say that the Federal and State rebates, like Queensland's $1,000 energy rebate, will reduce electricity prices by 20% to minus 0.5% from the overall inflation rate, while others argue that demand will push prices further with the greater disposable income Australians are getting.

Regardless, in the words of Treasurer Jim Chalmers, the 'last mile' of controlling inflation is going to be particularly challenging, and we need to suit up for this ride. The current economic landscape necessitates careful financial planning, especially for those with mortgages looming over their heads. Investors should stay informed about economic trends and the RBA's decisions, and ensure their investments are protected from the interest rate and inflation rate changes.

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