Some of the commentary I’ve heard lately on inflation and interest rates has made me realise that they are concepts not all Australians are comfortable with.
When the Reserve Bank meets each month to decide on official interest rates – as it will do shortly – it is performing its mandated task of keeping inflation within the bounds of 2 and 3 per cent.
Inflation is the increasing cost of goods and services. So, the Reserve influences inflation by increasing the cost of money by raising interest rates, which stops us spending.
Or, the Reserve can reduce the cost of money, which means we’re more likely to borrow and spend.
Our Reserve Bank does a very good job of this: our inflation rate is currently 2.7 and it doesn’t stray too far between 2.5 and 2.8 per cent.
But what people may not know is the extent to which the indicators of a healthy Australian economy are also inflationary.
For instance, Commodity prices are currently strong and our national income is in growth. Healthy indicators for Australia, yet also flags for the Reserve to look at using interest rates to cool the inflationary effects of this economic good fortune.
The RBA also looks at the not-so healthy aspects, for instance that households are not borrowing or spending much; that private investment is not strong and that asset prices have flattened.
But it also has to look at our terms of trade. We are getting better prices for exports than we pay for imports, which is very healthy for Australia.
So is the Australian unemployment rate. While many developed economies still struggle with unemployment after the GFC, we are forecast to dip below 5 per cent this year.
Yet these two factors are also inflationary because money in pockets equals borrowing and spending.
The Reserve knows that despite some flat asset prices and a reluctance to spend, that households will soon be borrowing, spending and buying property again. So they don’t rush to lower interest rates.
And through this complex picture, remember that the Reserve has to keep an eye on what’s happening in our biggest trade areas: North America, the European Union and East Asia.
Somehow, the Reserve gets it right. The latest figures on the Consumer Price Index saw inflation at 2.8 per cent in the year to the December quarter, after it was 2.7 per cent to the September quarter.
I believe the Reserve will hold interest rates this month. But it’s not something that people should use to decide whether they buy property, especially when you consider that most Australians have variable rate mortgages.
Property is at least a ten-year investment that allows for interest rate ups and downs – it is not something you should be worried about on a month-by-month basis.
Mark Bouris is the Executive Chairman of Yellow Brick Road, a financial services company offering home loans, financial planning, accounting & tax and insurance. Email Mark on mark.neos@ybr.com.au with any queries you may have or check www.ybr.com.au for your nearest branch.