WEEKLY E-MAIL

4 June 2021

IS INFLATION A CONCERN FOR THE SHARE MARKET?

By Ngoc Christodoulou

Inflation occurs when prices rise, decreasing the purchasing power of your dollars.

Don’t think of inflation in terms of higher prices for just one item or service. Instead, inflation refers to the broad increase in prices across a sector or an industry and ultimately a country’s entire economy. The chief measure of inflation in Australia is the Consumer Price Index (CPI). A CPI measures the average change over time in the prices paid by households for a fixed basket of goods and services. In Australia, the CPI measures the price of a fixed basket of goods and services acquired by household consumers who are residents in the eight capital cities.

Though it can be frustrating to think about your dollars losing value, most economists consider a small amount of inflation a sign of a healthy economy. A moderate inflation rate encourages you to spend or invest your money today rather than keep it under your mattress and watch its value diminish.

However, inflation can become a destructive force in an economy when it gets out of hand and rises dramatically.

As the share market is forward-looking, inflationary expectations affect it. A significant upward movement in inflation can hurt the share market. This is because inflation can reduce earnings. Higher input costs can squeeze profit margins, which in turn, places downward pressure on stock prices.

Stronger than expected inflation would encourage central banks to raise interest rates to prevent the economy from overheating. This can have a domino effect for businesses, as interest rate rises increases borrowing costs, which is added to already increased inputs such as materials and labour.

Is there a risk of creeping inflation?

Whilst Australia’s economic recovery has been stronger than expected, and the RBA Governor Philip Lowe is forecasting continued growth, recently released inflation data confirmed that inflation pressures remain subdued in most areas of our economy.

The RBA is predicting inflation to be 1.50% in 2021, growing to 2% by mid-2023. This is hardly an inflation breakout.

However, inflation is expected to temporarily rise above 3% in the June quarter due to bottlenecks resulting from COVID restrictions and international border closures. This results from Australians spending money normally reserved for overseas holidays and eating out, spending it on home renovations and consumer goods. This is causing temporary shortages and pushing up prices in some areas, such as the building industry. However, many believe that the current inflation rate is only transitory.

Judging by the ASX reaching an all-time high, the share market believes inflation risks are presently not a significant concern, at least in the short term.

Ngoc Christodoulou
Associate Financial Planner
Authorised Representative No. 1271825

If you have any questions or comments, please email me at ngoc@gfmwealth.com.au

Disclaimer: This document is not an offer or invitation to any person to buy or sell any interest in or deposit funds with any institution. The information here is of a generic nature, and does not take into account your investment objectives or financial needs. No person should act upon this information without firstly seeking competent, professional advice specifically relating to their own particular situation.

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