Q.ai - Powering a Personal Wealth Movement, Contributor
Nov. 9, 2022
Consumers are feeling the impact of sky-high inflation. As the cost of living goes up and purchasing power decreases, households are finding it more difficult to make ends meet.
Even though we all know that inflation is a problem, there is no single factor causing this financial pressure. Here are some of the main reasons behind the corrosive power of inflation.
- High inflation can be attributed in part to supply chain issues, steady demand, and energy uncertainty.
- The Federal Reserve has raised interest rates to combat inflation.
- Investors need to get creative to stay ahead of inflation’s negative impact.
Inflation hitting households
According to the U.S. Bureau of Labor Statistics, the latest Consumer Price Index shows that cost for urban consumers has risen by 8.2% over the last year. This means that households are facing higher costs. But what goods and services are facing the most change?
According to the report, gasoline costs are up 19.7% from this time last year. Energy services have also increased. For example, electricity is up 15.5% from last year.
Food is another area that is seeing higher costs. The cost of food people consume at home is up 13% from this time last year, while food eaten while dining out is up 8.5%.
It’s easy to see how these higher costs are putting pressure on household budgets. In fact, you’ve likely noticed the strain when fueling up your vehicle or checking out at the grocery store.
Main Drivers of High Inflation
In small doses, inflation is actually considered a good thing for the economy. However, with actual inflation well above the Federal Reserve's target of 2% annually, sky-high prices can negatively impact the economy.
Here’s a global view of the main drivers of high inflation .
Supply and demand mismatches
Since the pandemic, most of us have gotten used to seeing random items missing from store shelves. If you ask the manager about the missing items, you’ll likely hear them attribute the issue to a supply chain problem.
As we continue to move past the pandemic, some households have pent-up demand for specific items.
For example, many households are looking to purchase a vehicle. With demand remaining approximately the same, a decreased supply of new cars due to issues securing the necessary parts has created a perfect storm of soaring prices for vehicles. Thankfully, the used vehicle market is correcting itself.
The vehicle market isn’t the only one seeing this mismatch of demand with the current supply. When demand exceeds supply, that pushes prices higher.
The economy needs energy sources in order to function.
With the Russian invasion of Ukraine, there has been a significant shakeup in the world’s energy supply chain. Specifically, the invasion resulted in Western sanctions on Russia.
The impact of these sanctions means that Western countries are able to import less Russian oil.
As fuel sources become increasingly stretched and uncertain, the cost of powering the economy has soared. Rising energy costs put inflationary pressure on other goods and services because the cost to produce the goods or provide the services is higher.
For example, the cost of food might increase as a result of higher energy costs due to the higher costs of refining and transporting the item to your grocery store.
The Fed’s reaction to inflation
Although the Federal Reserve considers a modest level of inflation to be a good thing, the current inflation rate is far beyond the target of 2%. In order to combat inflation, the Federal Reserve began increasing the federal funds' rates earlier this year.
We saw the first interest rate hike by the central bank in May. Since then, there have been several more increases to the federal funds rate. As of early November , the federal funds rate was increased again to a target range of 3.75% to 4%.
As the Federal Reserve increases interest rates, the goal is to push back against inflation. With higher interest rates, the cost of borrowing increases.
Ultimately, higher borrowing costs tend to put a damper on consumer spending. After all, those who need to borrow money will be forced to pay more for the opportunity.
But, after a series of rate hikes, inflation hasn’t cooled as much as originally hoped. Only time will tell what actions must be taken to tame our current inflationary environment.
How to invest in light of inflation
In times of high inflation, the first priority of many households is simply finding a way to make ends meet. However, if you are in a position to invest, you’ll want to do as much as you can to stay ahead of the drain of inflation.
As an investor, it’s important to focus on your real returns, which account for your returns after taking inflation into account. For example, if your returns are 10% but inflation is 8%, your real returns are only 2%.
In the face of inflation, many investors choose to diversify with investments such as bonds, precious metals, and commodities.
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