Inflation Slashes Purchasing Power and Squeezes Family Budgets

GUEST ARTICLE: I wonder if the average Australian realises that a high inflation rate is really dangerous because it reduces their pay packet’s spending power at a time when prices for everyday products and services are rising?

inflation in zimbabwe
Due to the inflation now skyrocketing around 2.2 MILLION PERCENT, the 50 billion dollar bill you see here is worth less than two euros (less than three US dollars). photo credit: ZeroOne

There is no doubt that inflation is a serious issue and that it affects every Australian.

The Australian Bureau of Statistics (ABS) recently confirmed that the Consumer Price Index (CPI) rose by 4.5% for the 12 months to the end of June 2008.

So the recent June 2008 quarter can now add the esteemed accolade of the largest annual CPI increase since December 1995 to its trophy cabinet along with ridiculous crude oil prices.

It’s also prudent to note that when inflation last increased at this pace, the Reserve Bank of Australia set the Official Cash Rate at 7.50% (0.25% higher than the current OCR).

So it obviously begs the question … will the RBA continue to increase interest rates further despite their recent comments suggesting that Monetary Policy tightening had ceased? And whilst they suggested that a June quarter inflation increase was likely, it will certainly prove interesting to see whether they are still comfortable with inflation running at 4.5%.

Most importantly, you only have to look at the underlying index components to see just how much it affects every Australian’s take home wage.

The largest increases came from the Financial services and Transport sectors up by 9.9% and 6.9% respectively. They were closely followed by Housing (up 6%), Alcohol and tobacco as well as Health both up 4.8%. Coming in a close 3rd was Education and Food up 4.2% and 3.9% respectively.

And don’t forget the impact of the ever increasing cost of Fuel with the cost of Crude Oil rising above USD$145 a barrel during the same period.

In a recent podcast interview with Matthew Sherwood from Perpetual Investments, Matthew indicated that whilst we might experience some short-term reduction in the price of oil, we should get used to the idea of higher fuel prices over the long-term.

This means that the cost of fuel is likely to rise past the recently ridiculous price of $1.70 a litre – that’s already roughly $100 to fill the tank.

Wait it gets worse!

Those subscribing to the Peak Oil theory will tell you that pump prices could easily increase to the levels where filling the car could cost as much as $200 to $300 in the foreseeable future.

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I’ve said it before and I’ll say it again…bring on a national Fuel Watch scheme!

Let me give you a very simple example how increasing oil prices affect your net income…..

The cost of oil increases and causes the price of fuel to rise. In-turn, the input costs of production and manufacturing increases. Food production costs rise and results in higher grocery bills. CPI increases, the RBA tightens monetary policy and interest rates go up. In response, the banks increase mortgage rates and the credit crisis also means further rate hikes.

Now unless you are fortunate enough to get a promotion, pay rise or bonus, your pay is likely to remain stagnant, but your cost of living has increased.

So it now costs you more to go to the service station to fill the car to go grocery shopping where you spend more money and get less in return. And don’t forget your mortgage repayments have gone up and already soak up more than 30% of your net income, so you actually have very little or no disposable income left after other general living expenses and bills are paid. And we haven’t yet accounted for the 4.5% reduction in the purchasing power of your after tax income.

As a result, you find yourself sitting at home on the lounge of the weekends picking the fluff from your naval wondering why you work so hard and have nothing to show for it!

If only there was a market for naval fluff!

To put this into simple dollar terms, as a result of the increasing cost of production, manufacturing, transport and commodity prices, recent indications are that milk could rise to $3 a litre within the next 6 months.

Not to be left out, the other cornerstone of any staple diet is also on the rise as the cost of bread increases to $3.28 a loaf.

To put these prices rises into perspective, incorporating the new Minimum Wage rates which became effective 1 January 2008 and the impact of tax, and an adult working 38 hours a week will be left with only $2.82 an hour in the hand for their first hour worked.

Most importantly, ‘working Australians’ need to increase their incomes to help absorb the increased costs of living and the result is a circular inflationary wage spiral that is causing significant concern for both Australian households and economists.

What about buying cheaper goods I hear you say….

Even the historically cheap goods from Asia (in particular China), are also becoming increasingly more expensive as China fights annual inflation rates of 8%. As a result, China begins to export their inflationary pressures to Australia as we continue to import Chinese manufactured goods to combat even higher priced domestically manufactured items.

Charged with the responsibility of controlling inflation is the Reserve Bank of Australia (RBA) and they do so via Monetary Policy.

However, so severe is the global concern relating to spiralling inflation that even the International Monetary Fund (IMF) recently issued the RBA with a warning that they need to rapidly increase interest rates in order to counter act the sharp rise in fuel costs.

In order to avoid leaving you on a sour note, the recent July RBA Board Minutes did provide (in my opinion) a reasonably positive indication that monetary policy tightening may be subdued. And whilst they RBA continues to remained concerned about inflation, they acknowledged that the “existing policy setting was exerting the appropriate degree of restraint”.

Reference for Milk and Bread example

Milk, Bread

Minimum Wage:

  • Min Weekly Av Wage for Adult ($522.15) / 38 hours = $13.74
  • Min Weekly Av Wage for Adult ($522.15) * 52 weeks = $27,151.80

Tax

  • $1 – $6,000 – Nil
  • $6,000 – $30,000 – 15c for every dollar over $6,000
  • Net Income $17,979.03 / 52 = $345.75 / 38 hours = $9.098

$9.098 less Bread and Milk (6.28) = $2.82 net per hour.

Tim Hewson

This article was written by Tim Hewson, Senior Manager – Investments and Managed Funds, International Direct Banking at Raboplus

Tim has more than 12 years experience working in banking and financial services including Raboplus, specialist boutique investment firm Absolute Capital Limited and the Commonwealth Bank of Australia.

You can read more articles by Tim at his own blog, Confident Investor where he discusses topical financial issues and at the Raboplus Investor Centre where Tim writes a monthly hot tips column giving his opinion and commentary about investing and what’s happening in the market.

If you’re a blogger or an expert about a topic I cover on this blog I encourage you to contact me and I’ll consider publishing your guest article here including generous attribution and back links back to your website as thanks for your contribution

5 thoughts on “Inflation Slashes Purchasing Power and Squeezes Family Budgets”

  1. Inflation is reasonable and considered healthy upto a certain percentage like 2-3%..but hyper inflation or double digit inflation is worst!!!

  2. I think inflation is going to be a bigger problem than what it is today. The prices of essential commodities is rising by the day and if salaries do not increase in accordance with increase in income we could have a problem in had.

    I just hope governments across the world are able to come up with some solution.

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