“Inflation is the parent of unemployment, and the unseen robber of those who have saved” Margaret Thatcher
Inflation is getting much more press recently. During the latter parts of 2021, most central banks were describing it as “transitory”. However, several months later we have now seen an admission that inflation is likely to stay strong for a longer period than initially thought.
In New Zealand, the annual inflation rate has reached a high of 6.9% in the March 2022 quarter[1]. This follows 5.9% in December 2021 and is the largest move in New Zealand since 1990.
The most significant rise was within the housing and household utilities group, which was influenced by rising prices for construction and rental housing. Higher petrol prices have also added to inflation.
Across the globe, this 6.9% compares to the United Kingdom at 7% for the year to March 2022, and the OECD at 7.7% for the year ended February 2022. As at the time of writing USA consumer price growth surged at an annual rate to 8.6% for May 2022[2] with energy the primary contributor.
So, what does this mean for the average person on the street. Well, potentially a lot.
In response to this record inflation, Central Banks have increased rates, with the Reserve Bank of New Zealand having increased rates at every meeting since the 6th of October 2021[3]. This has resulted in an increase to the Official Cash Rate (“OCR”) to 2.00%, starting at 0.25% on the 18th of August 2021.
This increase to the OCR has had an impact on the wider borrowings rates, with the average two-year mortgage rate increasing from 3.47% in May 2021, to 5.62% as at May 2022.[4]
Higher rates will raise the cost of borrowing, and indeed the cost of refinancing. This will have the most significant impact on those that are due to refinance a large amount of debt in the near term. In dollar terms, this 215bps increase in the average two-year mortgage rate will mean an additional NZD179.17 per month in interest costs per NZD100,000 or mortgage debt. It is likely that those who financed in May 2021 will look to refinance soon given the current forecast rate trajectory (which is currently up), and near-term maturity.
Households will be further stretched by the continuing price increase in essentials such as food, petrol, power bills, rates etc. As such, those households with high debt levels, are unlikely to be able to mitigate increased interest costs very easily by simply scaling back on other areas of spending. It is also worth pointing out that lower income households are likely to be disproportionately impacted by rising prices as these households spend a greater amount of their household income on inflationary items.
A topical example is the cost of petrol. According to Gaspy, the average price for Unleaded 98 in New Zealand is NZD3.26 (an increase of 10.91% over the last 28 days), whilst the average price for Unleaded 95 is NZD3.12 (an increase of 7.17% over the last 28 days)[5]. Given the essential nature of petrol, it will be challenging for many households to significantly cut back on their petrol spending. A 10.91% reduction in driving to offset the increase in price may be possible in some cases, but for many it will be challenging. This is especially the case for businesses in the transport and logistics sectors.
With many of these cost increases being present in essential items, most consumers will not be able to simply cut the item from their budget like with other discretionary goods. Instead, the only real way to mitigate a price increase will be to reduce the use of the item by the amount of the price increase. This may be easier to do for some, as opposed to others.
At this point, whilst some will be able to mitigate the impact of inflation, no one will be able to fully avoid it; each person will need their own plan, based on their own circumstances, to reduce the impact.
For me and my family, our strategy has followed typical practices such as reducing our discretionary spend on gifts, eating out and takeaways, and not purchasing coffee as much from cafes. These are the items that can in some cases be totally removed from the budget, or at least significantly reduced.
The second part of the strategy has been to either limit or reduce the use of those items which are essential. These items are our groceries, petrol purchases, power, and utilities usage which can be limited by an amount, but not cancelled altogether.
This strategy has essentially resulted in splitting those costs out which are Fixed (those which need to be absorbed, but can potentially be reduced), and those which are fully discretionary, or Floating (those which can be cut altogether).
The Fixed items can be a little harder to reduce, but improvements can be made by reviewing an existing broadband provider, electricity provider, or simply looking at ways to reduce the volume of use. In the case of power, less use of the clothes dryer, and shorter showers or using heavier items on off-peak hours can make a big difference over the long run. This difference can be seen progressively, especially if your utilities provider has a tracker application to monitor daily usage.
Whilst we focus on monitoring our spending, we should also keep our minds on saving and investing. Often, people will look to draw down their savings before adjusting their lifestyle because of reduced spending power. In my opinion, this is a mistake. During challenging economic times, we should protect our savings as much as we can, and only dip into them should we lose access to other sources of liquidity, such as our salary or wage.
It should also be recognised that the spending power of our savings will reduce given inflation is likely to be higher than interest received on deposits. As at May 2022, the two-year Term Deposit rate in New Zealand was 3.43%, up from 1.11% in May 2021[6]. Compare this to the current annual inflation rate of 6.9%, and even a layman will see that interest on deposits will be quickly eaten up by current inflation (it should be noted that inflation is backward looking, but interest will be forward earning).
Given the impact on spending power, should you have the resources available, you may wish to increase your savings rate to account for the shortfall. Using the above Term Deposit and inflation figures, an increased savings rate of around 3.5% should negate the impact to ensure your savings are increasing.
The key to mitigating the impact of inflation is to know what you are spending your money on, and how much you are spending. As such, if you have not yet tracked your spending, start now. You are likely to find some easy wins which could translate into tangible achievements.
If you are already tracking your spending, well done. It may be a good time to review your spending and see whether there are any areas to trim. A post lockdown subscription trim may help, along with packing more lunches for work.
If you fall into this former bucket, and are unsure how to track your spending, I have constructed a simple budget template on an excel spreadsheet which I can distribute upon request. Please reach out via email to sjm@mindthemoney.org making comment that you would like to receive a copy of the budget spreadsheet.
This budget spreadsheet has some itemised expenses which can be amended for your own set of circumstances. The key is to look at the foundations of your own budget by splitting your spending and savings across the Red, Amber, and Green framework. You can then use these foundations to build your own unique budget which will suit your circumstances and achieve your goals.
Whilst these are challenging times, they are also an opportunity to realign our focus to the areas that really matter and reduce our waste both from a financial sense, and our environmental impact through reduced consumption. They key is to remain positive, and create bite sized goals to either reduce spending, or increase savings whilst keeping an eye on your long-term goals.
[1] Annual inflation reaches 30-year high of 6.9 percent | Stats NZ
[2] CPI Home : U.S. Bureau of Labor Statistics (bls.gov)
[3] Official Cash Rate (OCR) decisions and current rate – Reserve Bank of New Zealand (rbnz.govt.nz)
[4] New residential mortgage standard interest rates (B20) – Reserve Bank of New Zealand – Te Pūtea Matua (rbnz.govt.nz)
[6] New interest-bearing term deposit interest rates (B26) – Reserve Bank of New Zealand – Te Pūtea Matua (rbnz.govt.nz)
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