Tag Archives | inflation

The Big Squeeze

the-big-squeezeThe Big Squeeze

New Zealand’s rate of inflation continues to be low, even though our economy is growing. Lower petrol prices, cheaper airfares and computer equipment are some of the biggest contributors to low inflation and have reduced the impact of higher prices for housing-related goods and services. However, this is not necessarily cause to celebrate. The way in which people spend and save is very much influenced by the rate of inflation. Rapid increases in prices can cause people to spend now rather than later in order to buy cheaper. Saving becomes less attractive because the purchasing power of money declines over time. On the other hand, when prices are falling, spending is delayed in order to buy cheaper. The economy then slows down and prices can fall even further.

While high inflation is not desirable, neither is deflation (falling prices). The aim of the Reserve Bank is to keep inflation at about 2%; not too high and not too low. The principal tool for achieving this target is the Official Cash Rate (OCR), which in turn has an influence on the interest rates set by banks for deposits and lending. In theory, a lower OCR should mean lower deposit and lending rates for savers and borrowers. This in turn encourages spending and investment, leading to higher inflation. However, the OCR is only one of several factors that determine bank interest rates, so a change does not always achieve the Reserve Bank’s aim.

With inflation only just above zero, there is a danger we will head into deflation and the Reserve Bank is likely to continue to drop the OCR. If this translates into lower bank interest rates, savers will be caught in a big squeeze between falling interest rates and rising inflation. This is an uncomfortable place to be for retirees.

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Bank and Lose

Bank and Lose

Investors who retreated to bank deposits after the Global Financial Crisis now find themselves caught between a rock and a hard place. Do they stay in bank deposits for peace of mind but poor returns or do they venture back into investment markets? It is sensible to batten down the hatches when a storm blows over, but at some point, life has to return to normal. So how do you know when it is time to come out of your safe place?

People generally only change the way they do things to avoid an unpleasant situation or because they are attracted by something which is better. Over the last year, the consumer price index rose by 4.5%, thanks to GST and commodity price increases. Bank interest rates for 12 months are currently around 4.5%. However, after paying income tax of 17.5%, the net interest rate is around 3.7%. Invest $100,000 for a year at 3.7% after tax and at the end of the year, even after receiving interest, with 4.5% inflation your money will buy you the equivalent of only just over $99,000 worth of goods. This is not a pleasant situation! Rates, power, and petrol prices continue to rise and with low interest rates, bank investors will continue to lose wealth.

So what are the alternatives? In a nutshell, bonds, property and shares. That is not to say, however, that investors should move entirely out of bank deposits and invest elsewhere. Diversification is still the best investment strategy, but having at least a small part of a portfolio invested in shares will help protect against inflation. Over the last year, US, Australian and New Zealand share market indices have risen by around 13%, 14% and 7% respectively. These returns will surely entice bank investors out of their safe place.

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