Inflation erodes our purchasing power, and if we are not careful, we will become poorer year after year. Understanding the impact of inflation on our budgets allows us to plan accordingly.
The rate of inflation fluctuates all the time and is determined by a complex set of factors. This includes more people wanting to buy the same item, which drives up the price. As the cost of living rises, workers may demand higher wages, raising prices and causing an inflationary spiral. Droughts and other natural disasters, higher labour costs, higher exchange rates and logistical challenges may all contribute to an increase in prices.
The South African Reserve Bank uses interest rates to influence the inflation rate and economic growth. This is done via the repo or repurchase rate. When interest rates rise, debt becomes more expensive, and consumers have less money to spend. It’s also more expensive for businesses to borrow money, so they don’t expand as rapidly as before. Inflation rates decrease.
Lower interest rates mean more money available for consumers to spend. Borrowing is cheaper, so businesses expand, and inflation rises.
Inflation is measured by the Consumer Price Index (CPI), which is an average calculation of the changes in prices of a basket of items used by the average household.
The price of the items in the basket increases at varying rates. Historically, some items have increased substantially faster than the CPI rate, including:
In some cases, an item in the CPI basket may decrease in price during a given year. This could be because the price previously rocketed due to a market condition that has since corrected itself, such as the price of eggs being impacted by avian flu.
Alternatively, there could be new economies of scale in the production process or even a decrease in demand for the product.
Averages are interesting, but your personal inflation rate is more important to your pocket. It may be higher or lower than the official CPI, depending on which products or services you specifically use.
Use this calculator to determine your personal inflation rate.
The first step in fighting inflation is to make sure your income keeps pace with inflation. If you work for an employer, you may receive annual salary increases that, ideally, match the inflation rate.
If you’re self-employed, you will need to raise your prices for your goods or services to keep up with inflation. This is a delicate balancing act, as you also do not want to scare clients away with excessively high prices. The simplest method is to raise your prices in line with the inflation rate, but you may also want to consider the following alternatives:
If the increases in your income are insufficient to match increases in inflation, or your personal inflation exceeds CPI, consider taking further steps to maintain your standard of living:
After a lifetime of working and saving, pensioners are often hardest hit by inflation. It reduces the value of their capital, and medical expenses rise with age. Some expenses are not covered by their medical schemes, and they are affected by medical inflation.
Investment performance and interest rates are important, and if their income does not increase each year, they will become poorer over time. As a start, any capital they have invested must outperform inflation. Then their income must increase annually in line with inflation, but even if it does, medical inflation will erode their buying power year after year.
Some retirees receive a monthly annuity from a defined benefit pension fund. The pension fund trustees may grant an annual increase to all pensioners that is equal to or less than CPI. There’s no guarantee that this will keep pace with inflation.
If you buy a life annuity at retirement, choose an escalating annuity to ensure that your income keeps up with inflation. This will result in a lower initial income than with a level annuity, but you will be grateful for the increasing income over time.
If you receive income from a living annuity or a fixed interest investment, the investment performance or interest earned is a critical factor. You should avoid withdrawing too much capital as an income because you run the risk of running out of money.
