Have you heard the news? Inflation is skyrocketing in Australia and across the globe. Why? Governments have been printing and distributing money like it was going out of fashion for two and a half years (since COVID-19 arrived on the scene). The war in Ukraine and strong consumer demand are all adding to inflationary pressures here and abroad.
Why does inflation happen?
- Cost-push inflation: the cost to produce goods or services increases (higher petrol prices).
- Demand-pull inflation: suppliers cannot meet consumer demand needs when something is popular (prices naturally increase).
Why is inflation bad?
Less purchasing power (your money doesn’t go as far), fewer savings (the more you have to spend, the less you have to save) and loss of goods and services (like everything in life there are always winners (supermarkets, fuel suppliers and funeral parlours) and losers (generally discretionary spending).
Economies across the world are now doing everything they can to reduce inflation before it gets out of control (for some countries it may be too late). The main weapon against inflation is to increase interest rates which is commonly referred to as contractionary monetary policy. This reduces the money supply in the economy and by increasing the cost of credit, it reduces consumer and business spending. Higher interest rates on government securities (treasury bonds, bills and notes) make them more appealing to businesses and investors and it guarantees a rate of return. This, in turn, makes riskier investments like equities less appealing to investors.
The reality is governments have minimal options in the way of reducing inflation. The most common way is contractionary monetary policy (raising interest rates), but the downside is that it could tip the economy into recession. There is usually a lag of three to four months before the impact of interest rate rises is felt through the economy, so at the moment we are only feeling interest rate effects from April this year.
What does inflation mean for your investments?
Generally, higher inflation is usually seen as a negative for stocks because it typically results in:
- Increased costs of raw materials and labour
- Increased borrowing costs
- Earning expectations reduced.
Usually, due to the increased uncertainty of the value of money in the future, all of the above put downward pressure on stock prices.
In times of high inflation, investments in gold and commodities are generally seen as safe havens for investors. Energy and agriculture producers generally fare better in times of high inflation as people will always need to eat.
No doubt the inflationary and interest rate roller coaster will continue for the remainder of 2022 and well into 2023.
If you require assistance in navigating the coming economic environment, contact our experienced team of financial advisers. We can help you identify strategies to help you reach your financial goals and aspirations.
Please note this article provides general advice only and has not taken your personal, business or financial circumstances into consideration. If you would like more tailored advice, please contact us today.