Will Raising Interest Rates Help to Slow Down Inflation?

It’s been over a month since I wrote about my thoughts on business, the economy and what was going on. My last message encouraged listeners to stay calm as we ride out this wave of the economic cycle – Today’s entry is not much different from that original one in terms of timing.   There are however some qualifications around how long these cycles last, so let me explain these details whilst providing context for why they happen when they do! 

It’s no secret that inflation has been on the rise lately. The cost of living is increasing, and many people are struggling to keep up. The government has said that they are considering raising interest rates in an effort to slow down inflation. But will this really help? Let’s take a look. 

How long is this going to last?

The share market has taken a big hit this week and last, mainly because economists were not planning to see inflation rise in the USA and Australia this month. The reality is a lot of this inflation is driven by supply shortages, and therefore raising interest rates as the RBA has, won’t necessarily slow the economy (inflation) down as fast as the government would like.

In fact, there’s a chance that raising rates could actually lead to even more inflation. This is because when rates go up, consumers often start borrowing less and spending less. As a result, demand for goods and services goes down, which can then lead to businesses lowering their prices in order to attract customers. When prices start decreasing, demand begins to pick up again, restarting the whole inflation price cycle. The problem is that our price increases are driven by labour and supply shortages. 

So, while raising interest rates may seem like an effective way to combat inflation in the short term, it could actually end up causing more problems down the road. 

I was listening to Westpac chief economist Bill Evans speak last month, and whilst the cost of container transport and other supplies are falling (after massive rises last year), it’s going to be well into 2023 before we see inflation and the price of goods stabilise. Some takeaways from Bill Evans’ presentation were:

  • Major shake-out of the Australian housing market to occur this year.
  • Debt servicing on loans won’t go as high as predicted later this year or early next, giving people extra cash flow to service debts.
  • A lot of JobKeeper and JobSeeker payments will be going away in March and September respectively, which will also act as a drag on spending power and economic activity.

In short, we are in for a pretty bumpy ride when it comes to the economy over the next 12 – 24 months. Inflation is indeed a complex issue with no easy solutions. 

What does this mean for you?

The waves of the economy are always changing and it’s important to ride them as best we can. While things may seem tough now, they will change again and we need to be prepared for that. I’ve seen it personally, and with all our clients – everything is taking longer in business and life. We need to buckle down and weather the storm. But how do we do that?

  1. Whether it’s a bank loan application or your lawyer getting you documents to finalise that deal, you need to plan for it to take longer.  
  2. Have a plan ‘B’.
  3. Working capital buffers are essential in these times.
  4. Stay calm whilst we ride this economic wave.

What else can we do?

Well, firstly it’s important to remember that we are not alone in this – countries all over the world are facing similar challenges. 

Secondly, it’s paramount that we support local businesses as much as possible during these tough times – buy local where you can, and think about how your spending habits can keep Aussie businesses afloat. 

Lastly, if you are able to do so – now might be a good time to boost your savings account or investments. That way if things do get tough, you’ll have a buffer to help tide you over until things start picking up again.

It’s clear that we’re in for a long period of high inflationary pressure. This could have major implications for Australian households and the economy as a whole. 

If you’re concerned about how this might affect you or your business, be sure to speak with one of our team who can help you navigate these turbulent waters.

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