The last few months have been a volatile period for investment markets here in Australia and around the Globe. While volatility is a part of investing, news of high inflation, increasing interest rates and fears of a recession have caused a decline in markets.  

The table below shows the rate of inflation in key markets around the World:  

As you can see, the inflation rate is much higher than the generally acceptable rate of 2% to 3% each year. It’s important to note that Australia’s relatively lower inflation rate of 5.1% is for the March quarter, whereas the other economies have reported up to June.

Don’t be surprised to see Australia’s inflation rate increase as new data is reported in the coming weeks. 

What is inflation?

Inflation is the rate of increase in the price of goods or services over a given period. 

Inflation on its own is not always cause for concern. Indeed, low levels of inflation can be a positive for an economy; as knowing prices will be slightly higher in the future gives consumers an incentive to make purchases now, boosting economic activity. 

But high levels of inflation can be bad for an economy as it materially reduces the value of the consumers dollar, meaning they purchase significantly less with their money. 

What can be done?

Central Banks here and around the world are combating inflation using one of the only tools available to them; interest rates. 

During periods of high inflation, the Reserve Bank of Australia will raise interest rates to slow the economy down. Higher interest rates mean consumers (particularly mortgage holders) have less disposable income to spend within the economy. This causes a contraction in economic activity and can slow inflation as there is less money being spent. 

Unfortunately, this method comes with a risk of tipping the balance too far.

If interest rates rise too quickly and inflation is not brought under control, then consumers will be burdened with higher debt repayments plus higher prices for goods and services – a double whammy.

Businesses can also suffer as less spending means less goods sold which could result in laying off staff. This is the Recession fear we have been hearing so much about in the media. 

How will it end?

While inflation is high right now, many economists predict a return to more normal inflation in the years to come as rising interest rates take hold and other ‘supply-side’ factors are bought under control (e.g. the cost of energy coming down as alternate sources are used). 

For now, we just need to let Central Banks around the world manage this delicate balance, and hold faith that they will navigate the right path.