Economic e-News - August 2017

By Craig Turnbull
Chief Investment Officer


Inflation just isn’t what it used to be

In the 1970s and the 1980s the annual inflation rate in Australia reached double-digit figures, undermining people’s purchasing power, and eroding their savings and investments.

However, we now live in very different times. The average rate of inflation in Australia, as measured by the Consumer Price Index (CPI), has been steadily falling since the start of the millennium, and has now hovered below or just above 2% per annum for almost three years.

 

Source: ABS

Why is inflation important?

Inflation, put simply, is the rate of increase in prices across the economy. The CPI is a measure of the average change over time in the prices paid by households for a fixed basket of goods and services.

The CPI is important as it serves as the benchmark to set pay rates under many industrial awards, and to determine the size of increases in government pensions and other benefits.

Many economists argue that a moderate rate of inflation is required to drive consumption in the economy as it motivates people to purchase goods and services in the short term to avoid paying more in the longer term.

However, higher rates of inflation can deter people from saving as it reduces the value of their existing investments and eats into the returns on these investments.

Higher inflation can also encourage people to borrow more money as the real value of any outstanding debts shrink as the rate of inflation increases.

But the current problem for many developed economies around the world is too little, rather than too much inflation.

Is low inflation a problem?

The annual increase in the CPI fell back to 1.9% in the June quarter with rises in the prices for alcohol and tobacco, education, health and housing being partially offset by falls in the cost of clothing and footwear, transport and communication.

While prices for some goods, such as fruit and vegetables, can vary in the short term due to weather events such as drought and cyclones, prices for other goods have been steadily declining for years.

One reason for the long-term trend of falling inflation has been the rise of online shopping. Certainly the decline in the prices for clothing and footwear can be attributed largely to what many call the 'Amazon effect'.

Low inflation also means that many business are reluctant to raise their prices ahead of their competitors, and this has contributed to shrinking margins, cost cutting and lower levels of investment in capital, equipment and staff.

In Australia, new capital expenditure fell away sharply after the mining boom and this was not offset by any increase in the non-mining sectors of the economy.

But according to the latest NAB Monthly Business Survey, business confidence, conditions, and profitability are all rising, and this may finally lead to a much-needed improvement in business investment.

But what does this mean for your investments?

The combination of low inflation, low wages and low economic growth is not good news for investors or retirees over the long term.

In short, investors cannot expect to keep receiving above average returns from shares and property if our economic growth remains below the long-term trend.

The news on business confidence is welcome but it’s now crucial that this confidence flows through to healthy corporate earnings, higher capital investment and stronger wage growth.

And that’s the sort of things analysts are looking for in the current corporate reporting season.

 

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Markets at a glance

for the month ending 31 July 2017

downArrow Australian shares1 down by 0.01%
upArrow Australian Government Bonds yieldup to 2.625%
upArrow Australian dollar up to US$0.7987
noArrow Cash ratesteady at 1.50%
upArrow International shares up by 2.27%

 

1 ASX 200 Accumulation Index
2 Yield on 10 year Australian Government Bonds
3 RBA cash rate
4 MSCI – World ex Australia (USD)

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