Why is inflation important?

Inflation has important implications for your retirement savings. A low rate of inflation means that your savings will have more future spending power than if there were a high rate of inflation. Inflation has recently been low, coming in at 1.3 per cent over the year to 31 March 2019.

Relatively stable and low inflation is often a target of policy as it helps with decision making, and therefore promotes stable long-term growth. For example, unstable inflation makes it difficult to make informed purchasing decisions such as whether you should buy new tools now or later.

The Reserve Bank of Australia (RBA) aims to maintain a rate of inflation between two and three per cent per annum. Whilst there is no universally accepted ideal annual rate of inflation for Australia, two to three per cent; with some wriggle room is seen as the range consistent with stable long-term economic growth.

How does the RBA achieve its inflation target?

The main tool available to the RBA to influence the rate of inflation is the ability to set the cash rate. The cash rate feeds through to other interest rates such as those for mortgages, personal loans, business loans and the interest earnt by depositors in a savings account.

A decrease in the cash rate set by the RBA reduces the interest earnt in bank accounts which encourages people to spend, rather than to save their money. Any decrease in the cash rate also reduces the cost of borrowing money which both helps to reduce the amount many households spend on existing debts such as their mortgage repayments.

Lower interest rates can be an incentive to borrow money to invest in new tools, a new work car or maybe even to get some work to be done on the house. These flow on effects from a reduction in the cash rate all help to encourage greater spending in the economy and drive up the demand for goods (new tools or work car) and services (such as getting work done on the house) which could translate into an increase in prices.

Following the rate of inflation for the twelve months to 31 March 2019 coming in well below the RBA’s target rate, there has been a lot of discussion in the media recently suggesting that the RBA is likely to cut interest rates in the next few months in order to help stimulate activity in the economy.

What is Cbus doing to protect my super?

The target portfolios for the diversified options each can have an exposure to conservative assets such as cash or fixed interest. These assets generally derive at least some of their returns from an interest payment which may be affected by the RBA cash rate. Cbus’ diversified investment strategy aims to reduce the impact that any one asset class such as fixed interest may have on returns by investing in many different assets.

When looking at investment returns with a view to retirement, it is important to also consider the increase in the cost of living over that same period. A five per cent return doesn’t sound as good if the cost of living has also gone up by five per cent over that same period. This is why each Cbus diversified option has an investment objective[1] set as a percentage above the rate of inflation. The intention is that your retirement savings don’t just keep pace with the increase in the cost of living; but grow above it.

[1]  Information for the investment objectives can be found in the Cbus investment handbook.