Climate policy, interest rates and inflation
First up, climate policy. You may recall that Prime Minister Anthony Albanese promised to end Australia’s ‘climate wars’ when he was elected in May. And after decades of inaction and frustration, it finally feels like we’re moving in the right direction.
Earlier this month, the government passed the Climate Change Bill 2022 in the lower house of parliament which binds Australia to reducing greenhouse gas emissions by 43% from 2005 levels by 2030. And while there’s still a long way to go, it’s a massive first step and important symbol of our nation’s climate shift.
Meanwhile, in the US, another previously recalcitrant nation, we’ve seen the passing of a bill through the lower house that includes the largest burst of spending for the climate in the country’s history.
At Australian Ethical, we believe it’s extremely positive to see these kinds of actions taken up by governments, and further to see them navigating political systems to come into action. We’ve also seen Australia’s Environment Minister propose rejecting a coal mine on environmental grounds, the first ever move of this kind.
These wins give us hope but as we’re sure you know, they must be just the beginning of a decade of game-changing climate action. With a willing partner in government, investors and other actors can now seize the momentum for the kinds of radical action required and the opportunities the transition presents, and we can now be hopeful that our work will be met with support rather than obstruction from the government.
At the same time, speculation about interest rates has been generating plenty of chatter about the state of the economy and where it’s heading. And while interest rates moving around is normal, after four increases in four months you might be wondering about what this means for you and money.
So, let’s take a moment to unpack what’s happening in a Q&A below.
What’s going on?
At its September meeting, the Reserve Bank of Australia (RBA) announced it would increase the cash rate to 2.35%. This comes after hikes in May, June, July and August. These increases are significant as they are the first hikes in over a decade, bringing the cash rate up from record lows.
What’s the RBA?
The RBA is Australia’s central bank. Central banks are responsible for monetary policy in most countries’ economic systems. In Australia, the RBA is an independent body appointed by the Government with responsibility for contributing to the stability of the currency, maintaining full employment, and keeping inflation within a medium-term target of 2-3%.
You may have noticed recently that your money isn’t buying nearly as much as it used to. From petrol to electricity, groceries and fresh vegetables, the cost of living has risen steeply, with no signs of slowing. The reason for this is inflation, and it’s been rising quickly in recent times. Inflation measures the rate of increase in prices of a basket of everyday items over time. In other words, the change in the cost of living over time.
Why did the RBA increase interest rates?
The RBA meets monthly (except in January) and its primary tool for achieving its goals is setting the official cash rate (or interest rate). The decision the RBA takes on whether to raise, maintain or lower the cash rate reflects its assessment of both current and evolving economic conditions. If inflation is high, it might raise rates to try to cool demand and bring it under control; if inflation is low, it might lower rates to encourage people to spend and borrow money. That’s because when rates are low, it makes it less worthwhile to save and cheaper to borrow money. People are encouraged to save less and spend more, which in turn stimulates the economy.
For the decade before Covid, inflation had been well contained within or below the RBA’s target band (as mentioned above – 2-3%. This meant we had a sustained period of a low cash rate (also referred to as low interest rates). When the pandemic struck, and the outlook for the economy was potentially dire, the RBA lowered the cash rate to a historic low just above zero to boost economic activity. It also took less conventional policy measures like offering cheap funding to banks to stimulate borrowing and bond buying operations to keep liquidity in the financial system functioning.
It works the other way too: when the RBA assesses that inflation is too high, the RBA can increase the cash rate. This means it becomes more worthwhile to save money and more expensive to borrow money. Existing borrowers, like those people with a mortgage, will see their repayments rise and have less money (discretionary income) left over for spending on other things. This restricts consumer demand and economic activity to reduce the inflationary pressures that can result from strong economic activity.
And that’s where we find ourselves now. As we have emerged from the pandemic slump in activity, with the cash rate set to emergency lows, inflation has spiked, and it wasn’t clear if it was going to be a short-lived thing and go back down on its own. With the real risk that inflation was going to remain too high, the moves from the RBA these last months have been an attempt to contain it.
Today the cash rate has been set at 1.85%. The RBA’s forecast is that inflation will peak at 7.75% later this year. And while the RBA has emphasised there is no pre-set path, more hikes to the cash rate are expected before the end of the year.
Is this only happening here in Australia?
No. You may have seen in the news that the RBA isn’t the only central bank raising interest rates around the world. Many others, including the US Federal Reserve, the Bank of England, the Bank of Canada, the Reserve Bank of New Zealand and the European Central Bank have all also raised rates with the same aim as the RBA, to control inflation.
However, as it often takes a while for the effect of interest rate changes to flow through the economy, inflation can continue for much longer than expected. Getting inflation under control usually takes a while as the impact of central bank policies take time. Also, many global causes of inflation - like supply chain disruptions or commodity price impacts of the war in Ukraine - are outside the control of central banks.
What does all this mean for your super and other investments?
It can be unsettling to read headlines about inflation and interest rates and not know what it means for you and your super and other investments. But while share markets tend to respond erratically at times to political and economic events, like interest rate movements, any volatility is usually short-lived. It isn’t necessarily a cause for concern if you’re a long-term investor who’s still some years from retirement.
From what we’ve seen in the past, share markets bounce back eventually. As long as the economy remains strong and companies can grow their earnings, shares have historically performed reasonably well during periods of rising interest rates.
What is Australian Ethical doing to manage interest rates and inflation risks?
It’s normal to feel uneasy about what’s happening in the economy. The reality is though that all these ups and downs are a normal part of investing and something our investment team is prepared for.
Our Ethical Charter provides a stable lens through which to view the world. This means even when short-term returns are down, our approach to constructing our investment portfolios and advocacy remain unchanged. It’s how you can be sure your money is still invested for a better world for people, planet and animals.
What should you do?
Don’t make any rash moves. Take the time to assess whether you’re comfortable with your investment option for the long-term. Over the long-term, staying invested in a well-managed and appropriately diversified investment option can help you earn enough to beat inflation. Making changes to how your money is invested based on short-term volatility may mean missing out when markets rebound. History shows share markets eventually recover with time.
Past performance is not a reliable indicator of future performance. Australian Ethical offers a diverse range of investment options depending on your investment objective, timeframe and risk profile. This information is of a general nature and is not intended to provide you with financial advice or take into account your personal objectives, financial situation or needs.
Before acting on the information, consider its appropriateness to your circumstances and read the Financial Services Guide and relevant product disclosure statement (PDS) and target market determination (TMD) available on our website. You may wish to seek financial advice from a licensed financial adviser before making an investment decision.
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