High inflation explained, from cause to possible cure

If you are feeling the squeeze at the check-out, official data confirms what your receipt likely shows: prices keep rising.

In August, headline inflation jumped to 4 per cent from 3.5 per cent in July, driven by higher housing costs and automotive fuel prices.

At 11:30am AEDT, we will learn the September inflation rate.

RBA officials have pointed to the Middle East war, the AI investment boom and weak productivity as driving the current bout of high inflation.

Today's figures will help the Reserve Bank board, which will meet after the weekend, decide whether to raise interest rates for a fifth time this year.

Markets currently put the chance of a rate hike this coming Tuesday at about 65 per cent.

We asked ABC business reporter Stephanie Chalmers to explain the situation.

Inflation refers to the increase in the price of goods and services — essentially, how much stuff costs and how quickly those costs are increasing.

The inflation rate is a measure of how quickly or slowly prices are rising over a period of time, for example, a month or a year.

The common indicator of inflation is the Consumer Price Index (CPI), which is released by the Australian Bureau of Statistics every month.

It measures inflation in the price of a regular "basket" of goods and services that are commonly purchased by households — food, clothing, housing costs, energy prices and transport, among other things.

Because higher prices can hurt households. Inflation contributes to the increased cost of living, as your money won't go as far as it used to.

If prices keep rising faster than your wages, your so-called "purchasing power" is deteriorating.

That's what is meant by real wages going backwards.

If you get a 3 per cent pay rise, but prices have gone up 4 per cent, you're going to be worse off. Your wage has declined, once adjusted for inflation.

Inflation also means that the money you save will be worth less over time.

If you put your cash in a savings account in the bank, you will want to accumulate interest to ensure it keeps up with the rate of inflation.

But high inflation can erode the value of those savings. If interest rates aren't as high as the inflation rate, those savings will be able to buy less in the future.

The Reserve Bank says high inflation hurts everyone.

It targets a "low and stable" inflation rate between 2 and 3 per cent, on average over time.

The theory behind this target is that it helps people and businesses plan, with an expectation of what their money will be worth in the future.

But any level of inflation means prices are still rising, no matter how slowly.

That explains why the cost of living may continue to bite even as inflation eases — your grocery bill is unlikely to go backwards; it will just stop going up as fast.

It's also why people still seek wage rises, as they need to keep up with constantly rising prices, even in periods of relatively low inflation.

But some inflation is considered good for the economy.

The idea is that moderate price growth stops people hoarding their cash in the bank and helps spur economic activity and investment.

That's because you are less likely to wait to buy something if you think it will become more expensive.

And if you think your money will be worth a little less in the future, rather than it sitting in a savings account, you might try to grow it by investing elsewhere, for example, buying stocks in a company.

If prices start falling, that's called deflation. It can essentially create an economic freeze and create a spiral where businesses drop prices and then lay off workers or cut wages.

(The history of inflation targeting is another story — which begins in New Zealand. It's not ancient history either; it reached Australian shores in the 1990s.)

It comes down to a few economic fundamentals — supply and demand.

Prices may be driven higher by demand if people want more goods and services and there isn't enough supply to meet that demand. Think face masks during COVID.

On the flip side, prices can be pushed higher by factors affecting supply and input costs.

For example, the recent oil price shock, which hit supply rather than demand.

The resulting increased fuel cost flowed through to other businesses, and ultimately pushed prices up for their customers.

Another factor is inflation expectations. It refers to how people's beliefs about where prices are heading can affect prices.

If you're a shopper who thinks prices will keep rising, you might bring forward purchases and add to demand.

Or if you're a business owner who expects your costs to keep going up, you might lift your prices to cover it.

So the RBA would prefer you believe inflation is going to be "low and stable" in the future, and act accordingly, as it makes their job easier.

The RBA's main tool is the cash rate. It's an interest rate that affects the price of overnight loans between banks.

Banks then change the rates they charge customers.

Higher rates on home loans and business loans affect how much cash is available to spend by making it more expensive to borrow money.

That influences people's behaviour and, therefore, the demand in the economy. And when demand drops, prices should go down, in theory. Or at least, stop rising as fast.

After a rate hike, households with variable home loans can be left making higher monthly minimum repayments — money they then can't spend elsewhere.

If businesses have fewer willing customers, they will be less able to keep increasing prices, even as their own costs rise.

The RBA is effectively increasing one cost — the cost of your home loan — in an effort to contain others. It's a hard pill to swallow when you're just seeing your bills rise.

The central bank says higher rates encourage people to save more and spend less now, as they can earn more interest on their savings.

Asset prices, for example, stocks or housing, are also affected. Lower interest rates tend to drive up asset prices, making the people who own them feel wealthier and more likely to spend — and higher rates do the opposite.

And interest rates impact the exchange rate.

All else being equal, if Australia's interest rates are higher compared to overseas counterparts, it lifts the value of our currency. More dollars flow into economies where you can earn more interest.

If our exchange rate rises, imported goods become cheaper. And if people consume more stuff from overseas, it can take some heat out of the domestic economy.