What does inflation have to do with interest rates?

Jun 23, 2022
 

This week it's all about... inflation rates and interest rates

This week's video is a response to the questions I've received about inflation and interest rates - particularly, what does inflation have to do with rising interest rates? It's a quick video and I expand on it in next week's Uncensored Money Podcast episode.

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Transcript

Welcome to Mel's Money Musings.

This is a really quick one this week to talk about inflation rates and interest rates. And that is because I've been asked a question a lot in the last couple of weeks, as we are facing this time of rising interest rates is what does that have to do with inflation rates?

So what we know is that we are in a time of rising inflation rates and typically inflation rises at about two and a quarter percent. However, at the moment, certainly in Australia, it's tipped to hit 6 to 7% by the end of the year. And if we look at that over 10 years, two and a quarter percent, just over 20% over 10 years, you might seem, think, well, that's not too bad. Hopefully wages rise by about 2% a year. So that's a sort of increase in living that we can keep up with.

However, if we looked at 6 to 7%, over 10 years, that's 60 to 70%. And what we know is historically wages are not climbing that fast.

So what the government wants, what the Reserve Bank wants, is they don't want that galloping inflation. They don't want us to feel like living is becoming more and more expensive.

And I know a lot of people are feeling that at the moment, which is why, if you've missed it, we're running a free webinar on ways that you can find 5k by the end of the year, so that you can start to combat that.

But what the Reserve Bank has in its toolkit in order to reduce those inflation pressures is rising interest rates. And you might think, uh, why? Well, part of the reason we are spending at the moment is cause many of us have got more cash.

You know, if you, uh, one of the largest expenses for many of us is housing. And if you've got a mortgage at the moment, that mortgage is, should be typically incredibly low. Which is why thanks to stimulus over the last couple of years and low interest rates, Australians are sitting on more cash than ever before, which means we're spending more than ever before. Which kind of seems strange, but that's what's happening, which is why inflation rates are going up.

So what the Reserve Bank will look at is the lever they have to pull is rising interest rates. So that, that cost of housing goes up, which means that we are spending less. And that's the reason why we are gonna continue to see interest rates rise. And we are gonna see them continue to rise until inflation rates get back down to those more normal levels. And I think they'll rise until we are looking at 3 to 5%. And that's certainly something that in Australia, the Reserve Bank Governor has said, he's gonna be keeping an eye on so that he starts to, uh, take his foot off the brake of interest rate rises.

Now you going out and deciding not to spend tomorrow isn't gonna directly affect interest rates, but it's understanding that. It's understanding that more interest rates are coming. My prediction is though we'll have interest rate rises of one to one and a half percent more by the end of the year.

So if we know that, then it's keeping an eye on what's happening with inflation rates. If you hear a lot of talk about there's still climbing, you know, that there's more interest rates coming. If you hear that there's talking of easing inflation pressures, you know, fantastic, that's working. Hopefully we are getting to the end of interest rate rises.

So that's the two things to look at when it comes to inflation rates.

Any questions, if that doesn't make sense, but I mean, you're all economists now. You now all understand. Go ahead. Be smart at dinner parties.

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