Inflation, the gradual increase in the general price level of goods and services in an economy over time, is currently on the rise. This economic phenomenon, as simple as it seems, can have extensive effects on the broader economy, investors, and regular households.
The Cause of Rising Inflation
Inflation rates are currently surging, especially in economies like Australia, for several reasons. One key driver is the more robust-than-anticipated economic recovery following the COVID-19 pandemic. This resurgence has been powered in part by long-term emergency stimulus packages, such as JobKeeper payments and HomeBuilder grants, aimed at stimulating the economy.
For the past two decades, the prices of major items were primarily on a downward trend, largely due to the shift in manufacturing consumer durable goods to developing countries where overhead costs are lower. However, with lockdowns, an increased demand for items like home fitness equipment and computers emerged. As people spent more time at home, demand shocks were experienced, with governments pouring money into people’s pockets, which facilitated these purchases.
Compounding the issue, lockdowns also led to factory closures and supply shortages. Shipping costs soared by 400% due to the decommissioning of many ships, further exacerbating the situation. Political instability, like Russia’s invasion of Ukraine, has also escalated the prices of oil, gas, and several food items.
The Government’s Use of Interest Rates
To counter rising inflation, the government often employs a classic economic tool – interest rates. By raising interest rates, the cost of borrowing increases, which in turn lowers the overall demand for goods and services. This reduced demand can lead to a drop in prices, thus controlling inflation. Higher interest rates also incentivize savings, reducing the amount of money in circulation, which further helps to manage inflation levels.
The Investor Perspective: Good or Bad?
The impact of inflation on investors can be two-fold: it can be both good and bad. On the positive side, investments in certain assets like real estate or gold, often considered inflation hedges, can appreciate in value during inflationary periods. Stocks, too, can sometimes perform well, especially those companies able to pass increased costs onto consumers.
On the flip side, inflation can erode the value of money and the returns from fixed-income investments like bonds. As prices rise, the fixed interest payments from bonds become less valuable, negatively impacting bond investors. High inflation can also lead to increased interest rates, which can hurt stocks by increasing borrowing costs for companies and reducing consumer spending.
What Can You Do Now?
If you’re looking to protect your investments or capital against inflation, diversifying your portfolio can be a prudent move. Consider a mix of assets such as stocks, commodities, inflation-protected securities, and real estate.
Inflation is often a sign of a growing economy, but it’s essential to understand how it affects your financial position and investments. Staying informed, seeking professional advice, and being proactive in adjusting your investment strategy can help navigate periods of rising inflation effectively.
Contact us at Wealth Advisors and we can give you personalised and prudent advice for your investment needs in the coming markets. Inflation is still rising but with the government continuing to increase interest rates to combat this, now may be the time to start saving and start using that money to diversify your investment portfolio.
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