Last week, Australia’s Reserve Bank increased interest rates to their highest level in 15 years.
Unsurprisingly, the move dominated the headlines. Every news bulletin, social media post, and market commentary seemed focused on one question: where will interest rates go next?
Sounds legitimate enough, but for me that’s the wrong question. The much more pertinent question is this: what should you do in a high-inflation environment?
The reason interest rates are rising is simple. Inflation has become embedded in the economy and its stubborn. While higher rates are designed to slow demand and reduce price pressures, many of the forces driving inflation today are structural rather than cyclical.
The RBA has pointed to a range of factors contributing to persistent inflation, including significant investment in AI infrastructure, the transition to renewable energy, ongoing government spending, and the spending power of an ageing but relatively wealthy population, who subsequently don’t have a mortgage and actually have more income when rates go up.
Add to that the ongoing war in the Middle East and other global supply-side pressures, and it’s clear that many of the current inflation drivers sit beyond the influence of interest rates alone.
Even if some of these pressures ease soon, there is no guarantee inflation will quickly return to historically low levels, or that interest rates will fall significantly. So rather than obsessing over what the RBA might do next, investors should be asking a different question: how do you position yourself so that you don’t get left behind in a high-inflation environment?
The answer is surprisingly straightforward. Own assets, don’t sit on cash, and don’t sit on the sidelines.
Inflation increases the cost of almost everything. We see it every day in our grocery prices, insurance premiums, energy costs, and household expenses. But inflation doesn’t just increase the cost of food and energy bills. It also increases the cost of construction, labour, materials, and replacement value. Over time, this pushes up the value of many real assets, particularly property prices.
Inflation also drives rents higher as landlords pass on rising costs and developers stop building due to the abovementioned cost pressures.
The interesting thing is that Australia hasn’t experienced sustained, embedded inflation for more than two decades. That means many business owners, households, commentators, and even advisers have never navigated this type of environment before.
History, does however, provides a useful guide.
During the 1970s, Australia experienced inflation rates of around 10% or more for much of the decade. Over that same period, housing values surged, with prices roughly tripling.
In the 1980s, inflation remained elevated, with six years above 7%. During that period, Australian house prices more than doubled (150%).
Then came the early 2000s, perhaps the most relevant comparison to today’s market. Australia experienced seven consecutive years where inflation remained above 3%, and over those seven years, house prices more than doubled, rising approximately 130%.
Of course, property markets don’t move in a straight line. House prices may feel sluggish today, and many people are cautious because higher interest rates have reduced borrowing capacity and affected sentiment.
But that level of caution may be what leaves you behind. When inflation remains elevated for an extended period, asset owners often benefit in two very powerful ways.
First, the value of their assets tends to rise alongside inflation. Second, the debt attached to those assets remains fixed in nominal terms.
While interest rates may be higher, the underlying loan balance does not inflate. As rents, incomes, and asset values increase over time, the relative burden of that debt can become easier to manage.
This is one of the reasons previous generations, particularly the Baby Boomers, accumulated so much wealth. They owned assets through periods of sustained inflation in the 1970s, 1980s, and early 2000s. They allowed inflation to work in their favour rather than against them.
The lesson isn’t that interest rates don’t matter. Of course, they do. The lesson is that inflation matters more.
Too many people are focused on predicting the next rate movement when they should be focused on ensuring they are positioned on the right side of inflation.
Those who own quality assets may find themselves benefiting from rising values and rising incomes over time. Those who remain on the sidelines risk watching the cost of assets move further out of reach.
So instead of asking what interest rates will do next, ask yourself what you’re doing today to ensure you don’t get left behind if inflation remains higher for longer.
History suggests that inflation rewards asset owners. The opportunity is recognising that before everyone else does.
