By Jukka Viljanmaa, Senior Investment Manager, TPT Wealth

After many years during which inflation was low and stable, this important economic indicator is now rising not only in Australia, but around the world. While the jury is out as to whether this is likely to be a short-term or prolonged trend, it has important implications for investors, especially those with funds held in term deposits.

First, let’s take a look at the factors that are contributing to the recent lift in inflation, which refers to the way the price of goods, services and assets rise over time.

Price trends

In Australia, inflation is rising for a number of reasons. According to the Australian Bureau of Statistics’ figures for the September quarter, the Consumer Price Index (CPI) rose 0.8% during the quarter. Over the year to September 2021, headline CPI rose 3.0% with Reserve Bank of Australia’s favoured measure trimmed mean inflation increasing 2.1% year on year.

High fuel prices have made a significant contribution to rising CPI this year, with the price for automotive fuel jumping by 7.1% over the year to 30 September. Automotive fuel prices reached an all-time high in the September quarter. Other goods whose prices have lifted during this period include furnishings and household equipment (up 14.1% since March 2020), and motor vehicle prices (increasing 9.5% since March 2020).

It’s a similar situation in the US, where rising commodity prices, supply chain constraints and high shipping and transportation costs are leading to price rises. US CPI numbers reached a 13-year high in July of 5.4%, before easing to 5.3% in August as the price of used cars and trucks and the cost of transportation dropped. Earlier in 2021, Americans spent excess savings accumulated during pandemic-induced lockdowns and travel restrictions on purchases such as cars, pushing inflation higher. Inflation may continue to ease as savings are exhausted and government support packages are withdrawn as COVID abates.

Rising wages could lift inflation further

Back home, tightening labour market conditions could prompt inflation to spiral higher should this result in wages trending higher. The departure from Australia of 300,000 non-resident visa holders since the start of the pandemic has checked the unemployment rate for now as locals fill these jobs, with unemployment falling to 4.5% in August 2021. This is well below the 5.3% rate recorded in March 2020 before COVID had a chance to impact the labour market.

Right now, wages growth continues to be subdued, with private sector wages growth rising 1.9% for the year to August 2021 and public sector wages growth up by a smaller 1.3% for the same period. Policy makers including the Reserve Bank of Australia (RBA) will be keeping a close eye on wage growth trends when formulating monthly cash rate decisions.

The RBA’s main purpose is to keep inflation between two per cent and three percent and clearly, inflation is above this right now The RBA won’t move to raise the cash rate until inflation is sustainably within this band. RBA governor Philip Lowe has stated there are no plans to raise the cash rate until 2024, despite the market expecting rate hikes from mid-2022.

So what does all this mean for investors?

The official cash rate is at 0.1%, which means assets whose returns are determined by this rate such as term deposits are at all-time lows. Should inflation continue to creep higher, returns on term deposits will diminish further. Bank issued, 12-month term deposits are presently returning around 0.25%. With trimmed mean inflation at 2.1%, investors are receiving negative returns on cash investments and low-yielding term deposits.

So it’s important for investors who have allocated funds to low-risk investments such as term deposits to seek out alternatives that are still low risk, but that also produce positive returns.

The views and opinions expressed are presented for informational purposes only and are a reflection of the best judgement at the time the content was compiled by the Senior Investment Manager, TPT Wealth.