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Could rain cause inflation and interest rates to rise, hurting ASX shares?

There is talk that rainfall could lead to increased prices at supermarkets like Woolworths Group Ltd (ASX:WOW) according to the CEO.
The post Could rain cause inflation and interest rates to rise, hurting ASX shares? appeared first on The Motley Fool Australia. –

Interest rates

The Woolworths Group Ltd (ASX: WOW) CEO has warned that there could be higher meat prices because of the rain. Could this be a factor causing interest rates to rise, potentially hurting ASX shares?

Inflation talk

There seems to be talk of inflation and interest rates everywhere. Rain is probably not at the top of an economist’s list of things to watch for inflation, but the boss of Woolworths says that the higher levels of rain could lead to higher meat prices.

According to reporting by News.com.au, farmers are keeping cows on their land for longer to graze on the now-fertile land which can sustain bigger cattle herds at the moment.

News.com.au quoted the Woolworths CEO Brad Banducci, saying: “We do expect to see continued meat price increases…A lot of cattle are being kept on the land.”

The media piece also highlighted a couple of key quotes from the Meat and Livestock Australia’s 2021 Industry Projections report:

Improved seasonal conditions in southern Australia throughout 2020, and above-average summer rain in Northern Australia during the 2020–21 wet season, are expected to produce an abundance of pasture in all major cattle producing regions, with the exception of parts of WA.

The forecast fall in calf slaughter for 2021 is 7 per cent, reinforcing that the herd is entering a rebuild phase, and indicating producers will hold onto calves that otherwise would have been turn off as vealers.

What does this have to do with interest rates?

The Reserve Bank of Australia says that Australia’s inflation target is to keep annual consumer price inflation to between 2% to 3% on average over time. The meat price increases could join other goods and services that are seeing an increase in prices due to COVID-19 impacts, such as low supply and higher shipping charges. 

The RBA has an inflation target to inform its policy decisions. The target helps achieve its goals of: price stability, full employment and the prosperity and welfare of Australians.

Our central bank believes that low and stable inflation leads to sustainable economic growth.

There are a number of reasons why high inflation would be viewed as a bad thing.

If prices rise faster than wages, then they won’t be able to afford to buy as much as before.

Spending and investment decisions could be distorted.

Returns on investment may be lower. Regarding this, the RBA says:

Inflation influences investment decisions because a higher inflation rate will reduce the real return on the investment. Inflation can also affect the real interest paid by borrowers to lenders. For example, if inflation turns out to be higher than expected when the loan was agreed, the lender will get less than they had planned because inflation reduces the purchasing power of the interest earnings they receive.

The RBA says that when inflation is above its target, this can be a sign that the economy is overheating. If it is below the target, it may mean there’s spare capacity.

Then then cash rate can be adjusted to suit the situation. The RBA says:

The cash rate is then used to dampen or stimulate economic activity so that inflation is consistent with the target. If inflation is expected to be higher than the target for a prolonged period, the Reserve Bank would typically increase the cash rate. If inflation is expected to be lower than the target for a sustained period, the Reserve Bank would typically lower the cash rate. Changes in the cash rate take time to affect the economy. That is why the Reserve Bank looks to what inflation is forecast to be in the future when deciding on the level of the cash rate today.

Warren Buffett once described the relationship between interest rates and asset prices best when he said that interest rates are like gravity. He said when interest rates are higher, it pulls asset prices lower. When interest rates are lower, it can lead to higher asset prices.

So there could be an interesting period of time ahead for the ASX share market if inflation is high and interest rates have to go up in response.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Woolworths Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

The post Could rain cause inflation and interest rates to rise, hurting ASX shares? appeared first on The Motley Fool Australia.

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