Some recent questions on Australian inflation
By Robert Wright /August 21,2023/
- 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.
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.
Tips for Managing Money in Retirement
By Robert Wright /September 08,2022/
Aussies are living longer than ever before, with men expected to live until age 80 and women until age 85.
However, an increased life expectancy also means Australians may spend longer in retirement than previous generations, and in turn, need more money to fund retirement during those extra years.
When you’re retired and no longer earning money, it can be difficult to know how much you can afford to spend and what you need to preserve for the future, without the fallback of a regular retirement income.
You may also have added pressures in the mix, such as paying off debt, healthcare costs, and dependants in the form of kids or elderly parents.
Striking the right balance between enjoying your retirement and having enough to live on can be tough. However, you don’t have to go without – you may just need to consider your budget a bit differently.
If you’re planning your retirement , here are some money management tips that may help you get off on the right foot.
Look into having a U-shaped budget
Rather than a linear budget, where your expenses remain the same year after year, it may be worth considering a ‘U-shaped’ budget in your retirement. This is where your spending over the period of your retirement resembles a ‘U’, with the highest expenses in the first years of retirement and your later retirement years.
When you first retire, your spending will most likely be higher as you take that trip of a lifetime, splash out on that caravan or boat, or pay off your home loan (or all of the above) and engage in an active, and possibly more expensive, social life.
Your spending is then likely to settle into a more regular pattern in mid-retirement, before increasing again in your later years when greater healthcare costs and aged care expenses come into the mix.
Tips for paying off debt in retirement
Carrying debt into retirement isn’t ideal, but it’s a reality for many of us. If you find yourself owing money on your credit card, a personal loan or home loan once retired, there are things you could look into to help manage your repayments and minimise the amount of interest you pay.
Consolidating your debts by bringing them together into one loan could mean you pay less in interest, fees and charges. You could also contact your providers to try to renegotiate your repayment terms.
How much super should I have, and can I use this to pay off debt?
Some Australians withdraw their superannuation as a lump sum once they reach their super preservation age and use it to clear their debts, to avoid having any repayments and interest during retirement.
If you’re considering this, think about whether you’ll still have enough to live on in retirement, and the tax implications of doing this. In this case, it’s a good idea to speak with a financial adviser to weigh up your options.
Consider where you can save money
Although you may not have a steady income like before, it’s still possible to save money so you have more to spend on what’s important to you during your retirement. You can do this by leveraging some of the government’s benefits and subsidies, or by reducing your expenses.
Here are a few ideas to get started:
Consider selling your second car (if you have one), and take advantage of public transport concessions available to seniors instead. You may be able to save on car registration, insurance and maintenance costs, plus you’ll be doing a bit for the environment.
Take a look at government websites to learn about benefits and payments you may be able to access, such as pensions, allowances, bonuses, concession cards, supplements and other services.
Consider bundling your phone and broadband to save on technology bills, and your electricity and gas to save on energy costs. Compare providers’ rates through comparison websites and ask if they offer a seniors discount.
Think about ideas to entertain more at home instead of going out, such as dinner parties, game nights or movie nights. It also may be handy to subscribe for newsletters to your favourite restaurants and shops, or invest in a coupon book like the Entertainment Book, so you can take advantage of any offers and special deals when you do go out.
It may be worth putting your bills onto direct debit rather than paying them month by month. This way, you may be eligible to qualify for the pay on time discounts and avoid late fees if you forget a payment.
Groceries are a necessary expense, but it’s possible to save money here as well. Consider researching online for sales ahead of time, buying seasonally for fruits and veg, or buying in bulk and sharing with family or friends.
Tips if you’re helping your family financially
If you’re part of the ‘sandwich generation’, with elderly parents who are dependent on you and adult kids who are still at home or continue to need a bit of financial assistance, it’s still possible to have a good quality of life in retirement.
In order to do so, it’s all about finding balance. It’s important not to lose sight of your own goals during retirement, while still helping the ones you love. You may consider having some conversations with your children on the limits of what you can provide, and spend more time to help them understand the benefits of financial independence: for example, instead of financial assistance, perhaps you can help them with some invaluable financial education.
Tips if you’re estate planning
Estate planning is also an important part of your financial planning in retirement. Estate planning goes beyond just making a will. It can also be valuable to think about who your super beneficiaries are, and how you want to be looked after (both medically and financially) if you can’t make your own decisions later in life.
If you get your estate in order during the early years of retirement, it means more peace of mind in the long term and could potentially help prevent some family tensions in the future.
When planning your estate, here are some key things to think about.
Who will get your assets?
Making a will plays a big part in estate planning. A solicitor or estate lawyer can help you draw up a legally binding document that advises who should receive your assets after you pass away. If you don’t have a valid will, your estate will be distributed in line with the law in your relevant state.
Who is your executor?
An executor is the person responsible for making sure your assets are distributed according to your wishes, as well as paying bills, closing any banks accounts, and so on.
Who are the beneficiaries for your super?
Your super is often treated differently to the other assets in your will, so it can be useful to think about this as a separate aspect. Consider how you want your super to be distributed after you’re gone and try to keep your super beneficiary nomination up to date. If you don’t, there’s a risk that your super money may end up in different hands.
Who is your enduring power of attorney and/or guardian?
If you have an enduring power of attorney, you are allowing someone to make financial decisions on your behalf. In some states, your power of attorney holder can also make lifestyle decisions, such as health and medical choices and where you live, while in others you’ll need to appoint a separate guardian to do this.
Do you value your assets more than yourself?
By Robert Wright /February 18,2022/
Value is a funny thing. One person’s trash can be another person’s treasure, as the old saying goes. The value we place on something tends to be very individual, and is generally a product of many different factors ranging from cultural background and upbringing to personality type and even life stage.
But as much as the way we view value varies from person to person, there are also some common views that tend to draw us together. According to research commissioned by TAL, Australians are seven times more likely to name their possessions as their most valuable asset, rather than themselves.
The research revealed almost all Australians find it difficult to understand their own value. As a result, we tend to base our self-valuation on the amount we earn and own, while neglecting the intangible things such as the value of the social and emotional contributions we make to the lives of our loved ones.
The things we value will change over the course of our lives
Unsurprisingly, the research showed that throughout every generation, the things we place value on will change as we move through different life stages.
For those in their 20s and 30s, building a rewarding and successful career tends to be a strong focus, whereas those approaching or enjoying retirement tend to be more focused on staying healthy and supporting loved ones with practical tasks.
But where it gets interesting is when we look at how Australians felt their changing views on value over time had impacted the decisions they made along the way.
The long-term impact of our views on value
According to the research, the majority (78%) of Australians undervalue themselves and their contributions to others which over time has led to some regrets, including poor life decisions relating to their long-term wellbeing, as well as actions around protecting what they value.
The common views on value that draw us together
Despite our views on value changing as we move through different life stages, the research also found there are key areas of our lives which we are each underestimating when it comes to understanding our personal value, and this can subsequently have an impact on the choices we make.
In fact, Australians tend to fall into one of four different personal value profile types, which will influence the things they value and choices they make across their lives:
Gregarious Go-Getters (24% of Australians) – these people generally strive to have a successful career and are more likely to undervalue the importance of taking care of their health.
Conscientious Carers (28% of Australians) – these people highly value the emotional support they give to their loved ones but may question the decisions they make in life and sometimes wish they did things differently.
Family-Focused Optimists (32% of Australians) – these people tend to take a family orientated approach to life. They take care of their health but place less importance on their career than other areas of their lives.
Ambitious Organisers (16% of Australians) – these people are more likely to sacrifice their long-term happiness to focus on a successful career and tend to underestimate the value of their emotional support and time to loved ones.
So why does the way we view value matter?
With the research showing that many Australians believe underestimating their own value has led to some regrettable life decisions, it’s important to consider how your present choices may impact you in the future and the things you will come to value over time.
After all, you are your most valuable asset – in every hour of every day, month and year of your life, especially to your loved ones.
5 common financial mistakes to avoid during a crisis
By Robert Wright /August 07,2020/
The economic impact of the COVID-19 pandemic is playing havoc with finances for many households. In an ideal world, the financial boost should be enough and assumes that everyone was financially prepared for tough times. But in times of crisis, it can all be a little overwhelming.
Here are 5 common financial mistakes to avoid during a crisis and help you get to the other side with minimal money stress:
1. Not paying attention to the household finances
According to a study by Deloitte Access Economics, a worrying 14 per cent of Aussies struggle to pay their bills (including rent, mortgage, utilities and credit cards). The study found that 26 per cent are spending more than they earn and live from pay cheque to pay cheque. Taking time to pay a little more attention to your household budget will help you stay afloat financially and not fall into unnecessary debt.
Start by listing all discretionary spending and reduce non-essential spending as much as you can. Identify those recurring direct debits to subscription services you no longer use. Perhaps home cooking will do rather than Uber Eats. Schedule a payment plan with essential providers such as utilities and rates. Discuss holiday repayment options with your bank or landlord.
Try using a spreadsheet or budgeting app to make it easier to track your spending during this time. You’ll quickly get a true picture of your financial health.
2. Not building up emergency funds
The Deloitte study also found 13.4 million Aussies don’t have emergency savings to fall back on if they are out of a job. While we could not have predicted a pandemic, it certainly has exposed the financial vulnerability of not ‘saving for a rainy day’. A general rule of thumb is keeping aside three to six months of living expenses.
With banks letting borrowers hit pause on their home loan repayments, and as many as 375,000 individuals applying for the repayment relief, saving any excess surplus into an emergency fund to cover delayed repayments will see you in a stronger financial position.
3. Making emotional investment decisions
Share market volatility has seen global markets bounce around, resulting in lower investor confidence. With markets falling as much as 37 per cent, you may be thinking of abandoning your long-term investment strategy and cashing in your portfolio. However, share markets have proven that a recovery follows a crisis. The Global Financial Crisis of 2007 and the Black Monday Crash of 1987 are good examples. So, it makes sense to stay the course with a quality investment strategy whilst reviewing it regularly in line with financial goals.
4. Assuming your estate is in order
Half of Australians do not have a will. Of these, 34 per cent said they ‘haven’t got around to it.’ Without a valid will, your estate affairs end up in chaos. In light of the current pandemic which can have fatal consequences, setting up your estate affairs should be high on your list. A simple will can be drafted up by a lawyer for as little as the cost of smart TV.
5. Not seeking professional advice
In times of financial crisis, it might seem more affordable to take a ‘Do-It-Yourself’ approach to save on costs, rather than seek the advice of a financial advice professional. During COVID-19 crisis, the Australian Government eased the rigid regulatory requirements to allow more access to professional advice. Working alongside a subject matter expert such as a financial planner, may help you achieve a better financial outcome as well as putting your mind at rest about the future.
Source: Money and Life