Is this inflation or just a blip?

Many business owners are experiencing pent up demand, due to delayed expenditure carried over from last year and a renewed optimism from consumers. Extended lockdowns and harsh restrictions have been met with monetary and fiscal stimulus, which has boosted our economy. Share markets are back above pre-crisis levels, house prices are at all-time highs and business profitability is up   (with the exception of some sectors, notably entertainment and hospitality). This shows the power of coordinated stimulus measures from central banks and governments.

With this in mind, will the Reserve Bank of Australia (RBA) stick to their guns and delay official interest rate increases until 2024?

If we do see sustained inflation, the RBA may have to increase interest rates sooner than anticipated, flagging a big reset for asset prices. A change in the risk free rate, from which many asset managers build their valuation models, will have flow on effects if the Reserve Bank is forced to increase interest rates from the current 0.1%. The test will not only be if they increase rates, but also how they apply the brakes and communicate this to the market.

The real question is whether this is real inflation or just transitory. Are we seeing a permanent change in behaviour that will continue into the future beyond COVID-19, or are demand and the associated supply chain bottlenecks a result of the inability to spend as we normally would to travel and move about in the community? Are we merely seeing the short-term redirection of funds to home renovations, new car purchases, restaurants and local getaways?

The main factor to watch closely will be wages growth. Sustained inflation cannot persist without economy wide wages growth. Pre-COVID-19 we saw a decade long decline in wages growth due to a range of factors, including systematic action by businesses to cut labour costs, excess capacity in the labour market, technology disruptors, de-unionisation and enterprise bargaining agreements, and one of the largest contributing factors, low public sector award increases.

The current balance of supply and demand in the labour market is being affected by the closure of our international borders, but this will remain short-term as we hope to reopen our borders. The shift in spending outlined above will do little to drive wages growth, so we are unlikely to see the RBA forced to react and increase official interest rates in the short term. The RBA is far more likely to use other monetary policy measures to strike the right balance depending on what economic conditions warrant, such as recalibration of the Bank's bond purchases in either direction.

In any case, it will be interesting to watch this unfold and will play a critical role in how individuals position investments to navigate these uncertain times.

If you have any questions about the impact of inflation on your investments, or if you would like to discuss your personal financial situation, please contact your local BDO adviser today.


This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact the BDO member firms in Australia to discuss these matters in the context of your particular circumstances. BDO Australia Ltd and each BDO member firm in Australia, their partners and/or directors, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

BDO Private Wealth Advisers Pty Ltd ABN 62 805 149 677 AFS Licence No. 238280 is a member of a national association of separate member firms which are all members of BDO Australia Ltd ABN 77 050 110 275, an Australian company limited by guarantee. BDO Private Wealth Advisers Pty Ltd and BDO Australia Ltd are members of BDO International Ltd, a UK company limited by guarantee, and form part of the international BDO network of separate member firms. Liability limited by a scheme approved under Professional Standards Legislation.

BDO is the brand name for the BDO network and for each of the BDO member firms.

© 2021 BDO Private Wealth Advisers Pty Ltd. All rights reserved.