Inflation is the reason why $100 at the checkout today gets us a lot less than it did 10 years ago. Likewise, it’s how we know that our 100-buck shopping bag will be even smaller and lighter 10 years down the track. Our money gets less valuable over time, by economic design – and this is inflation.
Inflation is one of the most important financial concepts to understand, yet it can also feel like one of the trickiest. There are many powers at bay when it comes to inflation, and if the waters of the economic sea weren’t murky enough already with these powers, the endless, sometimes contradictory or untrue, commentary on inflation is sure to do the trick. You hear about it on the news, see it justifying rising supermarket prices and feel it when your budget suddenly doesn’t stretch as far as it used to. But what exactly is inflation, how does it affect your finances, and what can you do about it?
At Best Financial Planners, we believe the more you know, the better prepared you’ll be to make smart financial choices. So let’s break inflation down clearly, what it is, why it happens and how you can manage its impact on your daily life and long-term goals.
What is inflation in simple terms?
At its simplest, inflation is the rate at which the prices of goods and services rise over time. When inflation goes up, the same amount of money buys you less than it used to.
Let’s think about groceries again: a basket that cost $100 a few years ago may cost $110 or more today. Over the decades, the difference becomes even more dramatic. This erosion of purchasing power is the real “invisible thief” that inflation represents, and suddenly the amount you need to earn to live comfortably increases.
What is underlying inflation?
Underlying inflation is a measure designed to strip out temporary price swings that don’t reflect long-term trends. For example, sudden changes in petrol or fresh fruit prices can cause headline inflation to spike or drop, but these shifts often reverse quickly. Underlying inflation smooths out these short-term fluctuations, giving a clearer picture of persistent price pressures in the economy. In Australia, the Reserve Bank closely monitors measures of underlying inflation when deciding on interest rates, since it provides a more reliable guide to the true trajectory of prices.
How much will $20,000 be worth in 30 years of inflation?
The future value of money depends heavily on the rate of inflation. For example, if inflation averages 3% per year, $20,000 today would have the same buying power as about $8,239.74 in 30 years.
But while we know inflation will mean our money is worth less in the future, the variations in the inflation rate mean we don’t always know by how much. At a higher inflation rate, the erosion of value is even steeper – at 5% inflation, that same $20,000 would shrink in real terms to roughly $4,627.55.
These examples show why long-term financial planning is so important: without investments or growth strategies, savings left sitting idle will lose significant value over time. A financial planner in Sydney, for instance, can help you build an investment approach tailored to the city’s higher living costs and property market trends.
What causes inflation?
At its heart, inflation is caused when demand outpaces supply or when the costs of producing goods and services increase. In practice, it usually results from a mix of both. For example, if consumer confidence is high and households spend freely, businesses may struggle to keep up with demand, lifting prices. At the same time, if input costs like wages, electricity or raw materials go up, businesses raise prices to protect margins. This happened during COVID-19 when supply chains were totally disrupted – businesses struggled with meeting demand, and inflation accelerated.
However, governments and central banks also influence inflation through policy decisions on money supply and interest rates. So, inflation is both global and local. In areas like Perth where the mining and resources sectors drive higher household incomes, speaking to a financial planner in Perth can help you understand how local market conditions may influence inflation’s impact on your lifestyle.
What is causing inflation in Australia?
Inflation in Australia doesn’t come from a single source. It’s the result of both global and local pressures. Recently, three main forces have been at play. First, international events like supply chain disruptions and rising oil prices have pushed up the cost of goods. Second, strong domestic demand, boosted by government stimulus, low interest rates and household savings, has meant Australians have had more money to spend, putting upward pressure on prices. Finally, local factors like labour shortages and increased housing demand have made certain sectors more expensive. Together, these forces explain why Australians have faced steeper grocery bills, higher rents and pricier fuel.
While these are national forces, the way inflation is felt can vary by state and city, too. Financial planners in Brisbane might focus more on the cost of housing, mining and agriculture linked to Queensland’s economy, while financial advisors in Melbourne may highlight the impact of population growth and demand on rents and mortgages.
The link between interest rates and inflation
Interest rates and inflation move in a delicate dance:
- When interest rates are high, borrowing is harder, demand cools down and inflation slows.
- When interest rates are lower, borrowing becomes easier, demand grows and inflation can rise
For households, this means inflation can affect your mortgage repayments, car financing affordability and even credit card debt, adding to your total loan balance to account for the loss in value.
What are the five causes of inflation?
Economists often highlight five key drivers of inflation. These are:
- Demand-pull inflation – when demand for goods and services outstrips supply and causes a rise in prices.
- Cost-push inflation – when businesses face higher costs (like wages, fuel or raw materials) and need to pass them on to consumers to sustain their offerings.
- Built-in inflation – when workers demand higher wages to keep up with rising costs, which then pushes businesses to raise prices further, this is called built-in inflation, and acts like a reaction to the initial inflation ripple.
- Monetary inflation – when too much money is circulating in the economy, often due to low interest rates or government stimulus, supply can quickly outweigh demand and cause a general increase in prices.
- Imported inflation – when global prices increase (for oil, energy or food) flow into the local economy through trade.
How is inflation measured in Australia?
Since inflation is an increase in the level of prices of goods and services, inflation is measured by the rate of change of those prices. Economists usually measure inflation using the Consumer Price Index (CPI), which tracks the cost of a “basket” of common household expenses like food, transport, housing and healthcare.
In Australia, the CPI is calculated by the Australian Bureau of Statistics (ABS) and published once a quarter. To calculate the CPI, the ABS collects prices for thousands of items, which are grouped into 87 categories (or expenditure classes) and 11 groups. Every quarter, the ABS calculates the price changes of each item from the previous quarter and aggregates them to work out the inflation rate for the entire CPI basket.
Who benefits most from inflation?
Inflation affects everyone differently. Borrowers with fixed-rate loans often benefit because they repay debts with money that is worth less over time. Property owners may also gain, since real estate values and rental income often rise with inflation. Businesses with strong pricing power – like supermarkets or utilities – can pass higher costs on to customers, protecting profits.
On the investment side, those holding assets like shares, real estate or commodities can often stay ahead of inflation. In contrast, savers with cash in the bank and people on fixed incomes tend to lose the most, as their money steadily buys less. For instance, if you’re looking at how much you need to retire at 65 today, that number may have to be higher to account for a lower purchasing power when that time comes – unless it’s protected in investments.
How do you beat inflation?
Inflation is often spoken about in terms of our groceries or goods and services, but our whole financial portfolio is affected. For those saving for a house deposit, inflation can mean the power of your bank account shrinks in time without the right strategies. While you can’t stop inflation, you can reduce its impact on your finances, and the key is to make your money grow faster than prices rise.
On a day-to-day level, smart budgeting and cost control help protect your household cash flow, while regularly reviewing your mortgage, insurance and utility bills ensures you’re not overpaying. Finally, choosing a financial planner for long-term planning can help align your savings, superannuation and investments with strategies designed to outpace inflation.
How inflation affects investments and how to protect your money against inflation
Investing is one of the most effective strategies and assets like shares, property and inflation-linked bonds often keep pace with or outstrip inflation. Building a diversified portfolio spreads your risk and strengthens resilience – here are some foundational investments:
- Bonds – traditional fixed-rate bonds often struggle when inflation rises, because their payments lose real value. However, Treasury Inflation-rotected Securities (TIPS) and similar products in Australia adjust with inflation.
- Shares – companies with strong pricing power (like utilities or consumer staples) can pass higher costs to customers, protecting profits.
- Real assets – commodities, real estate and infrastructure often hold up well in inflationary times.
- High-yield interest savings accounts – these bank accounts pay you a high sum of money for storing your money, and the passive income from these accounts can offset the inflationary shrinkage of your money.
The bottom line
Inflation is unavoidable. But it doesn’t have to derail your financial future. Understanding what drives it, how it affects your daily life, and the strategies to manage it will put you ahead of the curve.
At Best Financial Planners, we specialise in helping Australians prepare for uncertainty, including the challenges inflation brings. Whether you’re saving for retirement, managing a mortgage, or building a diversified portfolio, our team can guide you toward smart decisions that keep your money working for you.
Talk to us today to learn how we can help you build financial resilience and protect your wealth, no matter what the inflation rates do next.
