Inflation can have a big impact on your personal finances, from mortgage rates to investment decisions. Here's your guide to how it works, how it influences the economy and what it means for you.

 

WHAT IS INFLATION?

 

Inflation is the rate at which prices rise. When inflation goes above 0%, it means that the dollar in your pocket buys less over time. At a 5% inflation rate, a basket of groceries that costs $100 today would cost $105 in a year's time.

Countries often cause inflation by issuing more currency to help cover debts from rising public spending (these days, typically using treasury bonds). This risks devaluing the currency. In the early 1920s, the German Republic suffered from runaway inflation (known as hyperinflation) after it printed more money to pay off war debts, causing citizens carrying suitcases filled with banknotes to buy loaves of bread. Thankfully, Canada's recent inflation has been far more modest. That's just as well, because inflation that rises beyond the Bank of Canada (BoC) ideal rate of 2% is unhealthy for the economy. As BoC Governor Tiff Macklem said in October 2022, rising inflation is a sign that demand is outpacing supply. One consequence of this is that businesses struggle to find enough employees to meet the demand.

Rising inflation is also tough on consumers, especially those on low or fixed incomes that don't rise in line with the inflation rate. Higher inflation means that their money doesn't stretch as far. It is also bad for savers since their savings are worth less as the rate rises. This is why inflation often prompts people to invest in growth assets (like stocks) because corporate growth can exceed inflation.

There is one area where inflation can be beneficial—repayment of fixed rate loans. The real interest rate on a mortgage is the mortgage rate minus the inflation rate. At 5% inflation, the real interest rate on a 5% mortgage is zero. As long as your income keeps up with inflation, a higher inflation rate makes it easier to pay your mortgage. The lender shoulders the inflation risk.

 

WHAT HAPPENED TO INFLATION IN CANADA?

 

Statistics Canada measures inflation using the Consumer Price Index (CPI), which averages prices across a collection of 700 goods and services sampled by researchers. These prices fall into eight areas, including food, shelter, household-related items, clothing, transportation, health and personal care, recreation and education, and finally alcohol, tobacco and recreational cannabis.

A larger annual change in the CPI reflects faster price rises. In Canada, the CPI actually fell by 0.4% year-on-year at the onset of the pandemic, plunging us into a moment of deflation. The CPI quickly recovered with the year-on-year change ranging between 0.1% and 1% for the rest of that year. Inflation started to increase rapidly. The rate of change more than doubled to 2.2% in the first quarter of 2021. It didn't stop at that sweet spot, but instead kept going and reached 8.1% in June 2022.

The BoC moderated inflation by raising interest rates, which increases the cost of borrowing, cooling off an overheating economy. In May 2023, the rate stood at 4.3%, but rose slightly the following month to 4.4%.

 

OTHER CAUSES OF INFLATION

 

Printing more money to manage debt isn't always the sole cause of inflation. A shift in supply and demand due to the pandemic also contributed to Canada's inflationary economy. COVID-19 caused businesses to curtail their production of goods, along with the production of commodities like oil and lumber. People also stopped spending on non-essential services, such as travelling and dining out. They began to buy more goods again as they settled in during lock down, but the scarcity of some products forced up prices. When economies reopened, pent-up demand for goods and commodities surged even further, but businesses were unable to ramp up production quickly enough to meet demand. A logistical shortage of transportation also disrupted supply chains. All of this made products scarcer still, fuelling higher prices.

As Canadians rushed to spend money on services again, restaurants and hospitality companies who had laid off employees found it difficult to recruit and train enough people. That increased the cost of doing business.

Russia's invasion of Ukraine created further supply chain problems. Between them, these countries produce critical commodities, including nickel, titanium, palladium, wheat and corn. Russia is also a major supplier of oil and gas to Europe. The conflict disrupted production of these commodities, putting a squeeze on global supplies. Economic sanctions against Russia drove up prices even further.

 

CALCULATING YOUR OWN PERSONAL INFLATION RATE

 

The CPI is a useful way to average out price rises across various types of goods, but each person's spending habits are unique. One Canadian might own their own home and spend a significant amount of money on driving to nearby towns to eat out. Another might pay rent, stay in more while studying for a master's degree and take the bus to get around. These two Canadians would see their monthly bills go up by different amounts because the prices for what they're buying don't rise at the same rate, due to their different lifestyles. Each of them will have their own level of personal inflation.

Statistics Canada does its best to weight categories of goods and services in the CPI. The average is weighted to reflect the proportion of their budget that the average Canadian spends on each thing. However, it also publishes a personal inflation rate calculator that allows people enter their own budgets so that they can see how much they vary from the overall CPI rate.

How you spend and invest your money has a big impact on how you weather high inflation and the rising interest rates that governments use to curb it. As your trusted advisor, I can help you manage your personal finances. Reach out today so we can talk about how to navigate an ever changing economy and keep your wealth planning up to date.

 

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CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc.
The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.
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