Understanding the Impact of Hyperinflation and Interest Rates on Canadian Finances

In one of our more recent newsletters, we touched on the dreadful reality of the current prime rate in Canada and how that is immediately impacting our variable rate mortgage holders. This week let's take a deeper dive to understand exactly why hyperinflation triggers the bank of Canada to hike the prime lending rate in the first place causing a double financial squeeze.

The Effects of Inflation on Everyday Expenses

In a recent survey conducted by statistics Canada more than two in five Canadians reported being most affected by the rising food prices. During the past year (April 2021 to April 2022), the price of food rose by 9.7%. Canadians had to pay much more for basic food staples, such as fresh fruit (+10.0%), meat (+10.1%) and fresh vegetables (+8.2%).
 

The Erosion of Purchasing Power and Budget Challenges

Now more than ever it seems that after cashing out your regular weekly groceries you find yourself reviewing your bill in detail thinking to yourself, “what did I buy that was so expensive”. The answer: the price of almost everything has gone up – a lot. A dollar here and there on each household item you pick up at the grocery store really adds up. Multiply that by 4 if you shop every week, and then by 12 and this number could represent hundreds if not thousands at the end of the year, buying what you have always bought, just paying more for the same thing. And that’s inflation. Which is why it's so important that we build inflation into our projected financial plans because you can see in real time just how inflation erodes the purchasing power of our dollar. The same study reported that after food, the most affected areas were transportation (32%), shelter (9%) and household operations (8%). (Statistics Canada 2022)
 

The Dual Financial Challenge: Interest Rates and Inflation

In Canada – as in the U.S., Europe and many other parts of the world – people’s budgets are being devoured from both ends at the same time. On one side we are experiencing higher interest rates, which we know in turn increases borrowing costs. On the other side is inflation. All this at a time when many organizations are planning salary freezes to combat ultra-squeezed margins business owners are experiencing as a result of inflation and rate increases. Wages in Canada are expected to go up 2.5% next year, and still this salary estimate falls below Canada’s inflation rate leaving workers struggling to budget despite a pay hike. (Benefits Canada)
 
Central banks are pushing interest rates higher to remove money from the economy forcing consumers and businesses to rein in spending and borrowing. This is all a strategic and proven successful strategy to curb hyperinflation, however achieving that end result will take time.
 
While mortgage payments and other loans are increasing, the expected benefit of increased borrowing costs (lower price increases on groceries and other essentials) has yet to materialize.
 
Just as we saw the percolation of price increases, borrowing costs percolate through the economy at the same slow pace. Gradually we will start to see price increases generally decelerate, which, in turn usually leads interest rates to eventually decline.

Navigating the High Inflation Period

Unfortunately, this approach does not precisely work in tandem. Inflation still remains high (6.9% as of Sept 2022) and there will be a level of discomfort for many for a while until inflation comes back to a healthy existence (2%).  Canada’s central bank doesn’t see inflation returning to its pre-pandemic normal until the end of 2024.
 
We’ll leave you with an attempt to shift your perspective a little. Over the last 20 years we have had the pleasure of working with and learning from a very special select intelligent and wise group of clients (age range approx. 70+). Among all of the other fantastic age groups we deal with, this particular age group has the most experience with rising and falling stock markets & interest rates, high levels of inflation, wars and even pandemics. These are often and easily our easiest group of clients to work with because they have experienced first hand what we are teaching and can validate the process and often enough teach us. They often speak calmly when talking about the history that is repeating itself because it will pass, and soon be something we refer to, not something we continue to talk about in the present. They have experienced what many are experiencing for the first time more than once in their lifetime and have grown wise in the decisions they made following these events. Many in this group were born during or coming off the hells of the great depression and raised large families of their own through several recessions on only one income and retired with money put aside all because they learned to not only live on less, but also saved while doing it. These habits are oddly enough best formed through experience. These conversations with our clients are easily some of the best and most rewarding as advisors. They learned to live on less when they had to and adjust their mindset to be happy. So why can’t we?
 
I read a quote this morning from an unknown source, and it read “Life’s weather is not yours to control, your work is to acclimatize your mindset”. We’re not saying this is easy, not at all. But there are lessons to be learned in every challenge or adversity in life, invaluable lessons that will last a lifetime if we just change what we choose to focus on.
 
And lastly, a newspaper clipping sent to us by one of our clients… who remembers these prices?