Tag Archives: Family

Some recent questions on Australian inflation

By Robert Wright /August 21,2023/

Key points

• The Australian inflation rate peaked in the December quarter but has been slower to decline than some global peers. While interest rate rises are helping to reduce inflation (especially as discretionary consumer spending slows), rises in domestic energy prices, a tight rental market and a lagged pick up in wages have contributed to higher than expected inflation outcomes.
• The main policy available in the RBA’s toolkit to manage inflation is interest rates, which is a blunt tool because of its unequal impact on households with debt.
• The burden of interest rate increases falls on households with mortgage debt. Businesses and investors are also impacted but the deductibility of interest provides some offset.
• Some countries in Europe have opted to use price controls for essential items to reduce inflation, with mixed results. Price controls tend to add distortions to the market and rent controls are not helpful while housing supply is limited (like in Australia).
• But the government still has a role to play in helping the RBA achieve its 2-3% inflation target through keeping fiscal policy neutral/contractionary if inflation is high, ensuring a well functioning energy market, maintaining sustainable wage increases, regulating businesses to discourage price gouging and monopolistic behaviour and calibrating appropriate migration targets to match housing supply.

Introduction

Australian inflation is very high. Consumer prices were up by 7% over the year to March, around a 33-year high but this was a decline from a cyclical peak of 7.8% in December 2022. The Reserve Bank of Australia (RBA) has been focusing on reducing inflation through the main policy tool available in the central bank’s toolkit – interest rates. The cash rate has risen from 0.1% in April 2022 to 4.1% in June – a 4% lift in just over a year. But, the impact on inflation so far has been lower than expected. As a result, we are often asked whether interest rates are actually having an impact on inflation or whether there are better tools available to policymakers, especially as interest rate hikes are having an unequal impact across household groups. We go through some of these issues in this article.

Are interest rate hikes working to reduce inflation?

Interest rate hikes have led to a slowing in consumer demand which is helping to reduce inflation. Discretionary spending fell in the March quarter and the volumes of retail spending was negative over the December-March quarter. Without the lift in interest rates, inflation may have increased further and consumer and market-based medium-long term inflation expectations could have kept rising well above the RBA’s 2-3% inflation target.

Some might say that rate hikes should have worked faster or better by now to reduce inflation. The problem has been that there have been numerous supply driven elements of the inflation story that have been less sensitive to interest rate changes. COVID driven supply chain disruptions led to big increases in shipping costs, commodity prices like energy, metals and agriculture increased significantly in 2021-22 (mostly from supply disruptions), domestic energy supply issues led to an Australian energy crisis and multiple domestic floods led to higher food prices. While these issues may not be directly influenced by the level of change in interest rates, it is the responsibility of the RBA to ensure that supply driven price changes do not leak into consumer prices. A lot of these supply related issues are now resolved but it takes time for it to be reflected in the final inflation figures.

Evidence of excessive price gouging by businesses is not obvious. Profit margins have expanded (increasing from 10% in 2020 to a recent high of ~16%) but have generally moved in proportion to the rise in inflation (see the chart below) and are now declining. The profit share (ex mining) of GDP has also been fairly stable. And slowing consumer discretionary spending means that continued profit margin expansion will be unlikely.

Source: Bloomberg, AMP

The peak of Australian inflation (in December 2022) also occurred later compared to some global peers which means that the slowing in inflation appears like it’s taking longer. US inflation peaked at 9.1% in June 2022 and in the Eurozone at 10.6% in October 2022 (see the next chart).

Source: Macrobond, AMP

Australia’s energy crisis occurred later relative to the Northern hemisphere, because of a raft of our own domestic issues like supply challenges with coal, a poor national plan for the energy transition and higher global prices. This meant that both the US and Europe were more impacted by an energy price surge in early 2022 from the war in Ukraine and the winter weather. Australia’s rental market also tightened significantly over the past year as net migration rebounded to record highs after the pandemic, pushing vacancy rates to ultra low levels in the capital cities and lifted rents, although recent vacancy rates across the capital cities have ticked up and newly advertised rental growth is slowing. Australia’s wage setting system also seems to have more “inertia”, with the minimum wage decision occurring once a year and many other wages like awards also based off this annual decision or driven by changes to headline inflation, which only peaked in December 2022.

While these factors all suggest that inflation in Australia could remain higher for longer for now, the good news is that our Pipeline Inflation Indicator still suggests significant downside to Australian inflation over the next six months and we expect headline consumer prices to be at the top end of the RBA’s target band by early 2024 (on a 6-month annualised basis).

Source: Bloomberg, AMP

Are interest rate hikes increasing inequality?

The impact of monetary policy works primarily through the lending channel because borrowing rates are priced off the cash rate. Households with a mortgage are the most impacted by interest rate changes. Businesses and individual investors are arguably less impacted because they can deduct the debt interest expenses. There are also other financial market channels that monetary policy works through, mostly through the exchange rate.

The high level of household debt now means that mortgage holders will bear the brunt of monetary policy changes. Renters can also be affected from higher interest rates if landlords are able to pass on the higher cost of debt servicing through higher rents. This is only usually an option in a tight rental market (which the current situation is allowing for).

In Australia, 37% of households have a mortgage (using data from 2019-20), 29% rent and 30% own their own outright. Detailed ABS data on housing costs shows that households with a mortgage spend close to 16% of their gross household income on “housing costs” (mortgage or rent and rate payments) as at 2019-20, owners without a mortgage spend 3% of their income on housing costs and the average renter spends close to 20% of their income on housing. And there are divergences across income quintiles (see the chart below) with the lowest income quintiles spending a very large share of income on housing costs.

Source: Bloomberg, AMP

Are there other options to combat high inflation?

The high degree of supply related factors that have increased inflation, the slow reduction in prices despite aggressive interest rate hikes and the high burden placed on households with a mortgage has led to questions about whether there are other options available to reduce the level of inflation.

The RBA has been tasked with the responsibility for the 2-3% inflation target but the only tool at its disposal is monetary policy. While the range of options within the toolkit has expanded beyond interest rates (including yield targets and quantitative easing) all of these measures ultimately influence the money supply and therefore the cost of borrowing.

The government has more tools at its disposal compared to the RBA through its spending and taxation decisions as well as regulation. However, these tools are slow moving and do not have as much of a direct impact on inflation. Some have argued that price controls need to be considered in Australia. Food price caps have recently been tried in Europe for some essential items, including in France, Croatia and Hungary with mixed impacts as measured inflation went down but there were reports of some food shortages.

Usually, economists do not advocate for price controls or caps because it’s a distortion in the market and leads to problems like supply shortages. However, the Federal government did impose energy price caps domestically, so it is already being utilised in some capacity. Talk of rent controls would likely add to supply constraints across Australia at a time when housing supply needs to lift.

But, the government does have a role to play in many components that impact inflation, such as by ensuring a well regulated electricity market, sustainable outcomes for minimum award and public sector wages which set the tone for the rest of the market, ensuring that fiscal policy (both state and federal) is appropriate for the state of the economy (we think the impact of the May Federal budget is more or less neutral but with the addition of some state cost of living benefits it could be marginally inflationary and the government could consider raising taxes to help get inflation down), regulation of retailers to ensure adequate competition and ensuring adequate housing for the migration targets.

Implications for investors

For investors, the good news is that inflation is expected to decline through the rest of the year which should mean that central banks are close to the top of their tightening cycles. This is generally positive for sharemarkets however, the further interest rates increase, the higher the risk of recession which is a risk for sharemarkets. The RBA’s recent hawkish stance means that further increases to the cash rate are likely in Australia. We expect another two interest rate increases from here, taking the cash rate to 4.6% which risks a recession in the next 12 months because of the heightened sensitivity of households to interest rate hikes in Australia.

Source: AMP

Expanding SMSFs for the expanding family?

By Robert Wright /May 19,2023/

It has finally happened. Recommended by the Cooper Super System review in 2010, put forward in the Federal Budget four years ago by then Treasurer Scott Morrison and finally passed on 17 June 2021, the maximum amount of members allowed in a Self Managed Super Fund (SMSF) has expanded from four to six.

Despite the previous maximum of four members, the vast majority of SMSFs had only one or two members therefore this increase did not exactly stop the press. Yet the question remains, why would an SMSF want six members and what are the disadvantages?

The most logical reason for a fund to grow to six members is to gather a larger pool of assets to invest. A larger amount to invest could open up residential and commercial property investment, or other nonstandard assets that require a large capital outlay, such as fishing licenses or marina berths.

Greater diversification for what many would consider standard assets, such as shares and managed funds, could be better achieved with six members.

Additionally, if the SMSF is paying fixed accounting and administration costs, having six members would also result in a lower cost per member.

If a large family is running two funds currently due to the previous four member limit, the funds can now be consolidated. However, it would be a capital gains tax event for the fund that is being closed down. Therefore consideration should be given to the unrealised tax position for each fund when deciding which to keep and which to close.

The main disadvantage of a six member fund is just that, the six members. The larger the fund, the greater number of people who are involved in the decision making process and the greater number of people who have to agree. With a greater number of members there is also the greater likelihood that there will be a falling out or there will be a marriage breakdown that could result in the division of superannuation. This would be particularly detrimental if the six member fund was established to invest in one large illiquid asset.

The chances of one of these unfortunate events occurring magnifies with each additional member, so it goes without saying that six member funds and the accountants and advisers that assist them will see their fair share of grief and the financial consequences that result.

For current SMSF trustees who are considering taking advantage of this legislation change, a review of the trust deed should be completed and a corporate trustee should be appointed if one is not already in place.

The SMSF member limit increase to six is good. It provides more choice in a superannuation environment which is known for restrictions and adverse government legislation changes. Opening up self managed superannuation funds to six members does increase additional investment opportunities, however serious consideration should be given to potential ramifications prior to proceeding down this path.

If you would like to discuss establishing an SMSF with six members, or adding members to an existing SMSF, please contact your financial adviser.

Source: Bell Potter

What to do when your fixed rate home loan term is ending

By Robert Wright /May 19,2023/

Many Australians were fortunate to lock in record low interest rates but this may be drawing to an end.

A large portion of mortgages will be approaching the end of their fixed term, leaving many households paying two to three times their current fixed rate.

In this article, we’ll explain what to expect when your fixed interest rate ends and how to prepare for it.

What happens when your fixed rate home loan ends?

When your fixed term is nearing its end, you’ll need to decide whether to re-fix your loan at a new rate, change to a variable rate or consider switching to a new mortgage provider.

If you don’t do anything before the fixed term lapses, on expiry your mortgage provider generally switches your loan to its standard variable rate, which can be much higher than some of the discounted options available to new customers.

The best thing to do is contact your provider and ask them about your options, including what rates they can offer you.

How to prepare

Consider reviewing your mortgage at least 3 months before the fixed rate expires, as this will give you time to implement changes if required.

Here are some steps to go about this:

1. Negotiate with your current mortgage provider

It’s worth speaking to your current provider in advance to find out what variable rate you’ll be paying. This gives you an opportunity to check out other rates available in the market and think about whether switching providers is a better solution.

You can also see if you can negotiate a better rate as this may save you a lot of effort in moving to a new provider.

2. Research what other mortgage providers are offering

Now is a good time to see how your loan stacks up against other loans out there. This will help you determine if you’re getting a competitive interest rate.

If you do find a better offer, switching providers can be a smart move but it’s important to look at the costs involved in switching, borrowing costs and switching fees, as these can often outweigh the benefits.

Before you make any decisions, crunch the numbers with an online mortgage switching calculator.

3. Consider re-fixing your loan

If you like the predictability that comes with a fixed rate loan, you can re-fix your mortgage with an up to date interest rate.

However, you will be locked into the new fixed interest rate for a period of your loan term, unless you choose to end the contract earlier which may result in break costs.

Be sure to also carefully check out the features of a fixed loan too, such as fee-free extra repayments, redraw and linked offset accounts. Many fixed rate loans do not provide these features.

4. Consider a split loan

If you’re struggling to decide between a variable or fixed rate, or if you’re keen on a combination of flexibility plus certainty, you can choose to have part of your mortgage fixed and part of it variable.

For example, you could have 60% of your loan on a fixed rate and 40% on a variable rate.

This approach can provide the best of both worlds. The variable rate component gives you flexibility, while the fixed portion shelters part of your loan from rising interest rates.

5. Get help from an expert

If you can’t decide which option is best for you, a mortgage expert may be able to steer you in the right direction.

Mortgage experts can look at your finances and recommend some of the best home loan options to suit your specific needs. They’ll also be able to guide you through switching to another provider if that’s the path you choose to take.

Get a home loan health check

A home loan health check could help you to:

• find ways to fine tune your loan
• get more certainty or flexibility on interest rate options
• reduce your repayments
• pay off your loan sooner.

6. Make extra repayments before your fixed rate ends

If it’s possible for you to do so, consider paying off as much of your mortgage as possible before you’re hit with a higher interest rate.

By reducing your mortgage balance before your interest rate increases, you could save a lot of money on interest payments before it moves to the new rate.

How to manage higher repayments

When your fixed mortgage rate finishes and your repayments start increasing, your finances may need to be reviewed to cope with the new reality of rising interest rates.

There are ways to help you save and potentially earn more money, which may compensate for the rate increase.

1. Review your budget

While it may not be an option for everyone, there are expenses you can cut back on such as:

• taking public transport to work to reduce petrol costs and parking
• online shopping habits
• expensive memberships that you don’t regularly use
• taking advantage of government and council rebates to reduce your energy bill
• switching to energy efficient appliances and lightbulbs
• reviewing your utility and insurance providers – there may be better deals on offer which could save you hundreds of dollars.

 2. Increase your income

Looking for ways to increase your income can help you manage higher repayments once your fixed rate expires.

Consider asking your manager for a salary raise or look for a higher paying job.

You could also consider starting a side hustle like dog walking or online tutoring to make extra cash. Another option is to rent out a room or parking space.

3. Consider opening an offset account

An offset account is like a transactional savings account linked to your mortgage balance. The funds in this account can reduce the amount of interest you pay on your mortgage, so holding your savings here can be beneficial.

For example, if you have a $600,000 mortgage balance and $100,000 in your offset account, you’ll only be charged interest on $500,000.

Source: IOOF

Why investing for retirement is different

By Robert Wright /March 07,2023/

When you’re still employed and earning a salary, there’s money coming in you can rely on. In retirement, in the absence of a regular salary you’ll need to find a new way to secure enough income to cover your living costs.

Investing your money is one way to make the most of your savings and provide an income in retirement but if you’re expecting savings and investment earnings to help cover your expenses, it’s important to get your strategy right.

Why timing matters

When accumulating super for retirement, you can afford to be patient. With years ahead to top up your super, you can stay invested during falls in the share market and wait for markets and your assets to bounce back. For the few years just before and after retirement, it’s a different story. This period, known as the ‘retirement risk zone’, is the time when you have most to lose from a fall in the value of investments. Your super has likely reached its peak in value and you want to make the most of these savings for your future retirement income.

In order to protect your savings and provide you with income throughout your retirement, it’s important to be aware of three key risks:

1. Living longer

Australians are living longer than ever before. Life expectancy has grown by more than 30 years in the last century¹. Living off retirement savings for 20-30 years or more introduces the very real risk of running out of money. So it’s no wonder more than half of Australians aged 50+ are worried about outliving their savings according to a 2019 National Seniors Australia survey.

We’re lucky that we live in a country that if your retirement savings run out; the Age Pension is there as a safety net but these regular payments may not be enough to maintain the lifestyle you’ve been enjoying in retirement. You could also be left with limited funds and options for aged care, if you should need it. That’s why it’s so important to make a financial plan early in your retirement so that you can help to protect your income now and in the future.

2. Inflation

Inflation measures the change in the cost of living over time and represents an important and often underestimated risk to your financial security in retirement. Given your retirement could last 20 plus years, there’s a good chance your savings and income will be affected by inflation. At an average annual inflation rate of 2.5%², a dollar today is worth roughly half what it was 25 years ago. Even this modest year on year rise in the price of goods and services can put you at risk of having an income that no longer covers your living expenses from year to year.

3. Share market performance

Share market performance is a risk for investors with exposure to investments such as shares, bonds and commodities. If you’re worried about market collapses similar to the Global Financial Crisis (GFC) in 2008, you’re not alone. A 2018 National Seniors Australia survey found that 7 out of 10 older Australians share your concerns.

Falls in the value of investments are impossible to predict and can make a big difference to income and financial security throughout your retirement. When investments earn negative returns, your retirement savings are falling in value. Crucially, if you also need to make regular withdrawals to pay for living expenses, it’s a twofold blow for your overall financial position in retirement. Less savings now means more potential for outliving those savings later in life.

Protecting your income and future in retirement

Diversifying your investments – balancing growth and defensive assets for example can limit the impact of market risks and inflation on your retirement savings. However, even with a well diversified portfolio, your super and Age Pension may not provide you enough income for your entire retirement. If you’d like the peace of mind that comes with a regular income for life, a lifetime annuity might be right for you.

Using a portion of your savings or super, you can invest in a lifetime annuity and receive regular income payments for life. It can act as a safety net ensuring that you will receive income for life, regardless of how long you live.

Talk to an adviser about the benefits of a lifetime annuity and whether it might be right for you.

[1] Australian Bureau of Statistics, Life Expectancy improvements in Australia over the last 125 years, 18 October 2017.

[2] Australian Bureau of Statistics, 70 years of inflation in Australia, Andrew Glasscock, 2017. Fig 2.

Source: Challenger