Few Investors Really Understand Inflation. Here’s What It Means

Inflation is driven by spending, not prices. It rises when total spending, especially borrowed money, outpaces what the economy can produce. In Australia, headline inflation rose to 4.0% in the year to August 2026 and the RBA lifted the cash rate to 4.60%, but the number that matters most for investors is the 3.6% trimmed mean: domestic inflation isn’t cooling. 

The trimmed mean, the RBA’s preferred underlying measure, has now held at 3.6% for a third consecutive month. Wages grew 3.2% over the year to the June quarter 2026, below both measures of inflation, which means real wages are going backwards. And in September the RBA raised rates for the fourth time in 2026. 

Headline data like this often gets lost in the noise of markets. Why do the forces underlying inflation matter so much? Because inflation is not really a story about prices. It’s a story about spending. Once you see it that way, a lot of standard portfolio advice looks like guesswork. 

Key Takeaways

• Inflation is best understood as total spending relative to the goods and services available to absorb it, and credit growth is its most powerful driver. 
  
  
• Australia’s headline inflation jumped to 4.0% in the year to August 2026, but the RBA’s preferred trimmed mean has held at 3.6% for three straight months, above the 2–3% target band. 
  
  
• July’s fall and August’s jump were both driven mainly by base effects and the end of fuel excise and electricity relief. Domestically generated (non-tradables) inflation is running at 4.5%. 
  
  
• The RBA raised the cash rate to 4.60% in September 2026, its fourth hike of the year, and doesn’t expect inflation to reach its target midpoint until late 2027. 
  
  
• Rather than inflating away their debts, governments in the US and Australia are fighting inflation at the expense of nominal economic growth. 
  
  
• With a 5% term deposit earning only about 1.4% in real terms before tax, investors may need to favour assets with pricing power, commodities and contractual inflation protection

Australia’s inflation at a glance 

Figures as at 16 October 2026. 

What Is Inflation? Spending Divided by Stuff 

Inflation is the rate at which the general level of prices rises. The most useful way to understand it is as ongoing nominal spending relative to the output available to absorb it. (“Nominal” means measured in today’s dollars, before adjusting for inflation.) 

Total dollar demand is on one side of the equation, while total real supply is on the other. 

Nominal spending comes from only three places: 

1. Income: tethered to the workforce, so it tracks economic output. 
2. Asset sales: these plug a hole rather than provide durable demand. 
3. Borrowing: bounded only by the willingness of lenders to lend and borrowers to borrow, so it can run far ahead of what an economy produces. That’s why credit cycles and inflation cycles tend to move together. 

Output is the slow-moving side of the inflation equation. Factories take years to build, and services are capped by the number of tradespeople and workers available. 

That asymmetry explains why demand is a stronger driver of inflation than supply, and why goods inflation tends to lead services inflation in both directions. 

Australian Inflation Unmasked: Why Headline Swings Hide the Real Problem 

Apply that lens to the latest local data and the picture is more worrying than either of the past two headlines suggests. 

In July, headline inflation fell to 3.5%, largely because of a base effect. A base effect is when the annual rate moves because of what happened in the same month a year earlier, not because of what’s happening now. An unusually large 1.3% rise in July 2025 dropped out of the calculation. 

In August, the base effect ran the other way. A 0.1% fall in August 2025 dropped out, and headline inflation jumped to 4.0%. Automotive fuel rose 14.8% in the month as the last of the federal fuel excise relief ended, and electricity prices were up 13.2% over the year as Commonwealth rebates finished. 

Strip out those one-offs and the breakdown is more revealing. Goods inflation was 4.2%, services ran at 3.7%, and tradables (prices largely set by global markets) were just 2.9%. Non-tradables, the domestically generated part of the basket, rose to 4.5%. Housing was again the largest contributor, up 5.7%. 

Much of the headline volatility, in other words, is imported and administrative: oil prices, excise and energy rebates. The domestic component, where wages feed into service prices, has not cooled. 

That’s why the trimmed mean, which strips out the 15% largest and 15% smallest price changes to reveal the underlying trend, has sat at 3.6% for three straight months. 

It’s also why the RBA, having held at 4.35% in August 2026 after three hikes earlier in the year, lifted the cash rate to 4.60% in September, its fourth increase of 2026. In August the RBA said it didn’t expect inflation to return to its target midpoint until late 2027. In September it said further tightening was warranted to return inflation to target “in a reasonable period”. 

A Key Shift: Why Nominal Growth Is Not the Attraction It Once Was 

There’s a part of the inflation debate that’s been wrongfooting plenty of sensible investors of late. Investors have long assumed that heavily indebted developed-world governments want to maximise their nominal GDP growth, even at the cost of higher inflation, since it’s the least painful way to manage ballooning debt. In other words, inflation allows governments to reduce the real value of their debts. 

Whether that’s still the case is debatable. 

The case for it rests on simple arithmetic. Take the US. The Congressional Budget Office projects US federal debt will rise from 101% of GDP in 2026 to 120% by 2036, well above the 106% record set in 1946. 

This is a costly trend. Net interest alone payable by the US Government now exceeds US$1 trillion a year. 

Circling back to inflation, nominal GDP (the economy’s output measured in current dollars, including inflation) is the denominator in every one of those ratios. If the US government allowed its economy to run slightly hot for a decade, it could effectively shrink its debt burden without legislating anything unpopular. 

However, US policy has gone the other way. Several years of fighting inflation have, in practice, been a fight against nominal economic growth and the wages, margins and commodity price strength that come when an economy runs hot. 

That’s not expected to change in the foreseeable future. The CBO’s baseline assumes inflation returns to target by 2030, rather than a debt load that’s effectively inflated away in the interim. 

And Treasury’s management of the yield curve is serving to flatten the very slope that encourages banks to lend money into existence, which is where nominal growth originates. 

This all spells an anti-growth agenda that’s at odds with the past. It’s not just being driven by a dislike of inflation and its effects. Social justice and green objectives have also been in play. 

In the words of Robert D. Atkinson: 

“For over a century, the core of American political economy was growth. Occasionally—such as during the New Deal—justice gained more prominence. But until the turn of this century, growth dominated. 

However, since then, growth has been on its back foot in the EU and the United States. In Europe, justice and green are the overarching priorities. Likewise, much of the Anglo world—especially Canada and the UK—has largely abandoned growth as a goal or preference in favour of equity and green.” 

Of course, Australia isn’t the US. But the Australian Government arguably has a similar fixation on reducing inflation at the expense of nominal economic growth. 

Moreover, Australia imports the consequences of US Government strategy through globally connected bond yields, currency markets and the price of everything bought offshore. 

Investment Implications: How to Invest When Inflation Stays High 

So, we’re arguably facing a world in which developed-market governments, including Australia’s, keep trying, without much success, to tame inflation at the expense of nominal economic growth. 

There are three main implications for investors. 

1. Why Cash Isn’t Safe When Inflation Is High 

A term deposit paying 5% is really earning only about 1.4% in real terms before tax with trimmed mean inflation at 3.6%. At the top marginal tax rate of 45% plus the 2% Medicare levy, the after-tax return of about 2.65% falls short of inflation, so the real return is negative. 

In other words, cash isn’t really safe. It’s expensive in terms of opportunity cost. 

Investors who don’t want to erode the value of their wealth will increasingly be forced up the risk curve, which pushes asset prices higher. Owners of risk assets with pricing power are positioned to benefit. 

Growth that accrues to asset owners instead of wage earners is a narrower and more fragile economic base, but it effectively forces investors to chase asset values higher. Global funds and global ETFs are one way to gain exposure to businesses with pricing power that may help hedge against higher-for-longer inflation. 

2. Commodities Are a Natural Inflation Hedge 

Commodity prices are a direct input into inflation, which makes them one of the more effective hedges against it. An allocation to commodities funds and ETFs may be prudent given the trends at play. 

3. Contractual Inflation Protection Beats Hope 

This backdrop is also likely to favour assets with contractual escalators, which pass inflation through by agreement rather than aspiration. 

Listed and unlisted infrastructure often carries CPI-linked revenue, and some property structures do too. 

On the credit side, floating rate exposure resets with rates while fixed rate bonds don’t. That’s one reason private credit has attracted so much Australian money and why many income strategies have outperformed. 

Tying It All Together 

In short, inflation is the relationship between how much is being spent and how much is being produced, driven mostly by credit. 

In a world where inflation stays higher for longer despite government efforts, it’s important to judge every investment return in real, after-tax terms. A nominal return that beats the cash rate but is negative after inflation isn’t a win. 

The investors who do well over the next decade are likely to be the ones who understand what inflation really is and prepare accordingly. 

Frequently Asked Questions 

What is inflation in simple terms? 

Inflation is the relationship between how much money is being spent in an economy and how much is being produced. When nominal spending, from income, asset sales and especially borrowing, grows faster than the supply of goods and services, prices rise. 

What is the trimmed mean? 

The trimmed mean is the Reserve Bank of Australia’s preferred measure of underlying inflation. It removes the 15% largest and 15% smallest price changes in the CPI basket and averages the middle 70%, so one-off swings such as fuel or electricity rebates don’t distort the trend. 

What is Australia’s current inflation rate? 

Australia’s headline inflation rate was 4.0% in the year to August 2026, up from 3.5% in July. The trimmed mean held at 3.6% for a third consecutive month, above the RBA’s 2–3% target band. The cash rate is 4.60%. 

Why did headline inflation jump to 4.0% in August 2026? 

Mostly a base effect: a 0.1% monthly fall in August 2025 dropped out of the annual calculation. Automotive fuel also rose 14.8% in the month as fuel excise relief ended, and electricity prices were up 13.2% over the year as Commonwealth rebates ended. 

Is 3.6% inflation high? 

Yes, relative to the RBA’s target. The RBA aims to keep inflation within a 2–3% band and steer it towards the midpoint. Underlying inflation of 3.6% is above that band, and in August the RBA said it didn’t expect to reach the midpoint until late 2027. 

Will the RBA raise interest rates again? 

The RBA lifted the cash rate by 25 basis points to 4.60% in September 2026, its fourth increase of the year and 100 basis points in total. It said it will do what is necessary to bring inflation sustainably back to target, so further hikes can’t be ruled out. 

Are wages keeping up with inflation in Australia? 

No. Wages grew 3.2% over the year to the June quarter 2026, below headline inflation of 4.0% and the 3.6% trimmed mean. When wages grow more slowly than prices, real wages and household purchasing power fall. 

Is cash a safe investment when inflation is high? 

Cash protects your nominal capital, but not necessarily your purchasing power. A term deposit paying 5% earns only about 1.4% in real terms before tax once 3.6% trimmed mean inflation is deducted. At the top marginal tax rate of 45% plus the 2% Medicare levy, the real return turns negative. 

Can governments inflate away their debt? 

In theory, letting inflation and nominal GDP run hot shrinks debt-to-GDP ratios. In practice, the US and Australia are prioritising lower inflation over nominal growth, and the US Congressional Budget Office projects federal debt rising from 101% of GDP in 2026 to 120% by 2036. 

What investments can help protect against inflation? 

Assets that tend to hold up better when inflation stays high include businesses with pricing power, global equities, commodities, infrastructure and property with CPI-linked revenue, and floating rate credit, whose income resets as rates rise. Each carries its own risks, so diversification remains important. 

Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.