The effect of rising inflation

The word ‘inflation’ doesn’t only dominate business news headlines, but finds its way into general news reports too. So, what is inflation and how does it affect you?

In simple terms, inflation signifies a rise in the price of goods and services, meaning you pay for more for every purchase you make.

Does the US influence Australia’s inflation rate?

It is not a surprise that countries in today’s world are more connected than ever before. Therefore, a rise in US inflation rates will impact Australian economy too, along with other countries. However, the degree and timing of its impact will vary. For example, a rise in labour costs in the US may have a limited impact on Australians; however, an increase in the price of iPhones or Nike shoes in the US will reflect in their price in Australia too.

What will be the impact of rising US inflation on Australia’s economy?

Interest rate movements made by the US Federal Reserve Bank (the Fed) are closely monitored by central banks worldwide, including the Reserve Bank of Australia (RBA). In recent times, many developed economies, including the US and Australia, have reduced interest rates to boost their economies. With rates nearing all times lows there is an expectation that rates will increase due to the strong performance of those economies. Quite often when the Fed increases its interest rate, Australia is quick to follow suit.

The cost of borrowing funds (home loans, business loans, personal loans etc) will increase, leading to a rise in the inflation rate, making goods and services more expensive. Rising inflation rates can also negatively impact the Australian dollar, where one AUD buys less USD than it may have done previously. This also affects tourists who may have to convert money before travelling, and can negatively affect individuals’ capacity to save money, especially if their incomes do not rise by the same rate as inflation.

What will be the effect on investors?

A rise in inflation affects investment markets negatively due to higher interest rates, volatility in the economy and uncertain share prices. For mum and dad investors, rising interest rates mean paying more interest on their home loan, which reduces their disposal income and, in turn reduces their capacity to invest. Growth in share prices can be volatile, meaning it will take them longer to build wealth.
For retirees, an increase in the price of goods and services at a time of share market volatility can lead to having to sell more of their investment assets (potentially at a loss or reduced profit). Also, there could be uncertainty in dividend income, which many retirees often rely upon. Retiree investors will have fewer years to recover from a drop in their portfolios compared to younger investors.