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Awakening to Inflation- 04.22 Thumbnail

Awakening to Inflation- 04.22

Michael D'Angelo- April 2022

Higher prices can chip away at your savings, so position your money to stay a step ahead. 

Monetary inflation hasn’t been much of a concern for so long that it may seem like a foreign concept to some people. Before the 1990s, wild swings in inflation were more common, but for the past 25 years annual rates have hovered close to two per cent, with few notable fluctuations. What a difference a year can make. 

When a large- scale reaction to the global pandemic began in March 2020, the Canadian economy entered uncharted waters. Global stock markets experienced their biggest drop in years, unemployment and business closures began to rise and supply chain interruptions soon contributed to a downward trend for the inflation rate, which eventually reached 0.72 per cent. However, it didn’t stay that low for long. 

The Bank of Canada boosted the economy by injecting massive amounts of money into the financial system through the purchase of bonds and other assets (known as quantitative easing). In late 2020, vaccine development gained ground and a return to higher consumer spending appeared on the horizon, fueling confidence in an economic recovery. Fast forward to 2022- inflation has now risen to 6.7%– the biggest year over year surge in nearly 30 years.

What is inflation? 

Inflation is the financial term that describes a rise in the Consumer Price Index (CPI), a measurement that reflects average changes in the cost of the typical goods and services purchased by households. The CPI is published monthly by the Bank of Canada.

When the economy gains strength, prices often go up. Today, as the pandemic recedes and the economy re-energizes, inflation is being pushed higher by a combination of factors. These include a return to consumer spending, a recovering labour market and the loosening of many COVID-19 restrictions. However, they are driving up the price of everything from furniture to cars to coffee. 

Effects of inflation

Popping into a grocery store, gas station or coffee shop today means paying higher prices than a year ago. And those aren’t the only places where you’ll face rising costs. You may also see them at the bank. This is due to the relationship between interest rates and inflation. When the Bank of Canada wants to reduce the rate of inflation, it raises interest rates. Raising interest rates raises the cost of borrowing money in the form of mortgages, loans, and lines of credit. 

With the speculation of several more upcoming interest rate hikes, Canadians can expect to make higher payments due to higher interest rates on their debts. This means households may have to look closely at holding back on their spending and focus on paying down their high-interest debt.

Handling inflation

It’s debatable whether the economy has entered a temporary or a prolonged period of inflation. While the experts monitor and measure all the factors that affect inflation in one way or another, consumers can continue to stay focused on our long-term goals and re-examine what we can do to make up the shortfall in our purchasing power. If the average annual inflation rate is, for example, 2.5 per cent, a person needs to generate a return of at least 2.5 per cent on their money or risk losing some financial ground to rising prices. Since very few savings and other types of cash accounts, such as GIC’s pay anywhere near this amount of interest these days, investing in a diversified portfolio may offer the best protection against inflation. 

Another option to consider is taking a gradual approach towards investments to benefit from dollar-cost averaging. Making regular investment purchases, buys more units when prices are low and fewer units when prices are high, effectively lowering the average cost and providing the potential for greater growth over the long term. 

It’s important to also recognize that investments come with certain levels of risk – which is why it is crucial to determine your own tolerance for risk with the help of an advisor.

What might the future hold?

It’s logical to expect that the post-pandemic Canadian economy will continue to strengthen through rising spending, investment, trade, and employment. Meanwhile, influential economists and investment strategists believe that over the next year or two, inflation will trend higher than we’ve seen in the last 10 years.

Investing advice

Cash has a hard time keeping up with inflation. It’s important to be aware of how easily savings can be turned into a loss by a weakening of your purchasing power. Rather than relying on traditional savings accounts, exposing your money to the markets could earn better returns that keep pace with or, possibly, outperform the negative effects of inflation. 

Investment choices have broadened over the past decade. There is more flexibility now than ever to build a portfolio with growth potential that remains safely within your risk tolerance. Speak with your advisor, who can help you take advantage of new opportunities as they arise and ensure your finances can stand up to potential challenges.