Should you worry about inflation and interest rates? Understand your situation.

Apr 13, 2022 | Financial coaching, Mortgage, Property, Reflection, Retirement, Superannuation

Bring up the topic “finance” with any person at the moment and inflation and interest rates are the two concerns that seem to be on people’s minds. So how do they actually affect your finances? Let’s take a look.

Inflation over the decades

The consumer price index or CPI is calculated by the Australian Bureau of Statistics (ABS) every quarter. The next release is due on April 27. What will this information tell us I hear you ask?

The Reserve Bank of Australia (RBA) has a target to achieve an inflation rate of between 2 and 3 per cent on average. The following chart shows inflation since it was first compiled by the ABS in 1960. In the table, we can see how inflation has spiked from a record low after COVID in 2020 to a level of 3.5% for the year ended December 2021.

The graph shows an average across all households in Australia and applies to both renters and home owners. Your personal or household inflation figure is likely to be either above or below the average depending on where you spend your money. For example, if you grow your own vegetables and don’t use fuel then price changes for these items will have no effect on you. However, most of us  are not in that situation and are directly seeing the change of fuel and food costs.

Changing consumption habits

The next chart shows our consumption for different items. Since COVID hit, you can clearly see the changes and large variations. The two areas that saw significant falls were the use of transport services, hotels, cafes and restaurants. The highest spend line was purchases of vehicles.

Understanding your individual inflation levels

Upon inspection of the two graphs, you are likely to ask yet another question, so what does this mean? What it shows is that your personal level of inflation is likely different to the average.

The average helps us make key decisions.

The upcoming CPI figures on April 27 may put pressure on the RBA to raise interest rates to try to curb inflation. This is likely if the figures are worse than expected or desired. How does that work?

If interest rates go up it costs more to borrow money. If this happens, people may think twice about borrowing for that new car. Higher interest rates also mean higher repayments for variable rate loans which means less money in consumers’ pockets and less money to spend.

Increasing the cash rate could soften spending and in turn lower inflation.

However, this may not work so well for items that are not discretionary. Or for products  that cannot have its price reduced due to ongoing supply shortages. The same goes for products facing increases in production costs domestically and abroad, products with supply chain issues and so on.

Inflation is bad for retirement

If inflation keeps increasing over time and stays high, it does have a very detrimental effect on retirement plans. Inflation means you are spending more and essentially need more money to fund your income needs.

A recent article highlighted the significant difference between an average of 2% and 3% long term for inflation. Your annual estimates may no longer get you the same comfort you planned for.

Is there much you can do?

If you are so inclined, you could work out your own inflation level to better understand where you are in comparison to the average. You can do this by comparing your regular spend each month on food, fuel, clothes and other fun activities with the same month last year. That should give you an indication of where you are at and what you might need to do.

If this sounds like too much effort, simply wait until April 27 to see what the Australian average will look like and any potential responses by the RBA. As usual, if you have questions or concerns today, please don’t hesitate to reach out and discuss. Your financial health is my priority.

Financial Advisor and Founder – Core IFA

About the author

Simon Duigan is an Independent Financial Advisor and owner of Core Independent Financial Advice (Core IFA). Core IFA is proud to be the first and only Tasmanian business to be approved by the Profession of Independent Financial Advisers (PIFA). This means Core IFA is independent and receives no commissions or benefits from any product providers or financial institutions. Instead, you can be confident that Core IFA have your best interests at heart.


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