Learn the fundamentals of inflation in Australia
See how the inflation rate could be influencing your finances and spending habits. Plus, economic predictions for the next few months.
The inflation rate has been a topic of widespread discussion in recent months with rates rising well above the country's benchmark. As the cost of living continues to increase alongside inflation, Australian’s are concerned about how it will impact their personal and household finances.
In this blog we’ll be explaining how inflation works and its role in Australian economic policy.
What is inflation?
Inflation is a term used in monetary policy to explain the “increase in the level of prices of goods and services that households buy.” The Reserve Bank of Australia (RBA) sets the priorities of monetary policy in Australia. They have three goals, being; influencing stability of currency, maintaining full employment, and ensuring economic prosperity and welfare of people within Australia.
Inflation is a factor that works in with the first goal (influencing stability of currency). According to the RBA, the transmission of monetary policy is influenced when the RBA changes the cash rate. This then influences banks with their interest rates. Off the back of that, it further influences consumer and economic activity, which finally affects the rate of inflation.
Please see image below or refer to this prior article we wrote on the cash rate and the Australian economy, to learn more about the transmission of monetary policy.
How is the inflation rate measured?
The formula that the RBA uses to measure the rate of inflation on an item is as follows:
What is the inflation rate target for Australia?
The RBA aims to target inflation between 2 to 3 per cent. This range has been identified as flexible when supporting them in being able to achieve their three priorities (previously mentioned). When it’s between this target range, it’s less likely to affect people’s economic decisions.
What happens if the inflation rate is too high?
When the inflation rate gets too high, the following can occur:
Purchasing power of consumers is reduced – meaning they can’t afford to purchase as many goods and services
Workers seek wage increases to compensate living costs. In turn, this can influence a reduced employment rate
People’s spending and investment decisions are altered
Lower returns on investment
Businesses may increase their price on goods and services
Or when the inflation rate becomes too low…
Likewise, when the rate is too low, the following can occur:
Consumers can delay purchases, which can lead to…
Deflation of the costs of goods and services
Businesses can face difficulties with reducing real wages of employees and lay off workers
What is Australia’s current inflation rate?
To date, the inflation rate is sitting at 5.1 per cent. This is much higher than the target set by the RBA. With inflation being as high as it is, Australian’s are facing challenges with keeping up with the cost of living. Dr Philip Lowe, the RBA’s Governor anticipates inflation to reach 7 per cent by the end of the year.
While the immediate outlook for the cash rate is high, economists and the RBA expect it to decline. This will then bring the inflation rate down to between the 2-3 per cent range, next year.
In the last quarter, goods and services that have been significantly impacted by inflation include transport, housing, household services and furnishings, education, and food/ beverages. For a more detailed list of increases in the last quarter, please refer to the image below.
Combating inflation with a higher cash rate
To combat the rate of inflation and maintain monetary policy in Australia, the RBA have implemented higher cash rates. With several cash rate rises in the last few months, the RBA have stated that this measure will help balance out the demand for and supply of goods and services. This point was reiterated by Dr Lowe who stated, “as we chart our way back to 2 to 3 per cent inflation, Australians should be prepared for more interest rate rises.”
Additionally, Dr Lowe said, “the board also gave consideration to the fact that the level of interest rates was still very low.”
Staying ahead of your finances and mortgage repayments
If you’re concerned about your mortgage and want to learn more about refinancing opportunities, we’re happy to help. REIF are supporting homeowners with staying ahead of their financial commitments and ensuring they can keep up with rate rises. To have your situation assessed, please click the button below to book a free consultation with our team of finance specialists.