Inflation is defined as an increase in the general level of prices for goods and services, and it is measured as an annual percentage. Inflation can be caused by increases in the cost of living, such as higher fuel and food prices, or by shifts in spending patterns from items that have become relatively cheaper to those that have become more expensive.
In Australia, inflation surged to its highest level in over three decades in the third quarter of 2020. Headline inflation was 1.6% for the quarter and 3.0% for the year. The main drivers of this increase were higher prices for petrol, child care, electricity and housing.
In order to protect the purchasing power of consumers, central banks aim to contain inflation within a narrow range. Too little inflation, known as deflation, is normally seen as a sign of economic stagnation, but high inflation quickly erodes purchasing power and can ‘overheat’ an economy, leading to major problems.
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Higher prices for petrol
In the third quarter of 2020, petrol prices rose by 18.9% for an annual increase of 33.1%. The price increase is due to higher crude oil prices and a carbon tax on petrol from April 2020. The rise in petrol prices was the main driver of inflation in the third quarter, accounting for around 0.6% out of a total 1.6% increase in inflation.
Child care costs also rose sharply in the September quarter, up by 7.4%. This was partly due to the introduction of a new Child Care Subsidy (CCS) which replaced the former Child Care Benefit (CCB) and Child Care Rebate (CCR). The CCS provides families with means-tested subsidies to help with the cost of child care. For families who are not eligible for the subsidy, child care fees increased by 3.4%.
Electricity prices rose by 2.1% in the September quarter and were 5.8%. The price increases are due to a combination of higher network charges and the introduction of the Emissions Reduction Fund in July 2020. The Emissions Reduction Fund is a carbon pricing mechanism that imposes a cost on emissions from the electricity sector.
Housing costs, including rent, utilities, and property taxes, rose by 0.7% in the September quarter and were up by 2.4%. The increase was driven by higher rental prices, which rose by 1.1% in the quarter and 2.7%. The higher rental prices were due to strong demand for rental properties and a lack of supply.
What effect does this inflation have on forex trading?
High inflation is seen as a sign of economic weakness and so causes forex traders to expect a decline in the value of the currency. As a result, market movements can cause the value of a currency to decrease relative to other currencies when there is higher inflation in the home market.
Inflation can make it difficult to save money
As inflation increases, so does the cost of living, so people have to spend more money on necessities like food and housing. It can make it difficult to save money since people have less money left after paying for their essential expenses, so profits made from trading are spent on living instead of putting it back into trading and making more profits. The loss of value in money also means a higher return is required to maintain a stable portfolio value.
Inflation can lead to higher interest rates
When inflation is high, central banks often respond by raising interest rates, making it more expensive for people to borrow money and leading to higher mortgage payments and other debts. Brokerages may increase their fees, and traders will have to put down more money to trade.
Inflation can reduce the purchasing power of people’s incomes
As prices increase, people’s incomes go less and less far because the same amount of money can’t buy as much as before prices went up. Over time, inflation can reduce the purchasing power of people’s incomes, making it challenging to afford essential items like food and housing.