Inflation is rising: Here are 5 ways it could impact you

Have you tried to buy a car lately, but didn’t remember the price being so high? Or maybe you’re renovating a house, but your contractor keeps telling you how expensive lumber is these days? It’s not a coincidence. Over the last few months prices on many consumer goods, from food to housing to gasoline, have climbed.

In August, Canada’s Consumer Price Index (CPI) — the metric which measures the change in price of a set basket of consumer goods and services — jumped by 4.1% from a year earlier, the highest increase since 2003.¹ Other items not included in the CPI, like commodities such as copper and lumber, have also spiked, with the latter rising 261% on the Nasdaq between January 2020 and May 2021.²

These price gains are what’s called inflation, a term many Canadians have likely seen in news headlines. It’s worth paying attention to as rising prices could impact your finances, though inflation may not be as scary as you might think.

How does inflation work?

Inflation follows the basic law of supply and demand. Higher inflation suggests that demand for goods and services is rising faster than the economy’s capacity to produce them. Take lumber: With so many homeowners stuck inside over the last year, demand for two-by-fours and other wood products needed to renovate or build new homes has soared, while supply couldn’t keep apace. The result? Higher lumber prices.

For the most part, rising prices shouldn’t raise much concern. Inflation can be a sign of a strong economy, and central banks in both the U.S. and Canada generally expect to see prices rise by between 1% and 3% per year.³  We’re talking about this now, because as the economy enters what many expect could be a post-pandemic boom, there is some concern that prices could jump too high too quickly. If everyone starts spending again and as more people return to the workplace, then demand for all kinds of goods and services could increase, which would push prices higher.

So, what does inflation mean for your money? Here are some ways everyday Canadians can feel the effects of inflation:

Higher cost of living

One main effect of inflation is a potentially higher cost of living. The more prices rise, the more money you’ll need to spend on buying items. While you can cut back on certain things, such as travel or home furnishings, you’ll still have to buy other items, like food or gas for your car. If you have a budget, accounting for inflation is simple: Increase your spending in the areas most important to you, while cutting back in others.

Purchasing power erodes

You can’t have a conversation about inflation without mentioning purchasing power, which refers to how much one unit of money can buy. Rising prices will have an impact on your purchasing power, especially if your income stays stagnant. How? One dollar might buy you something today, but if that item costs $2 tomorrow, and you haven’t earned more money to keep up with the increase in the price, then your ability to buy that item has decreased.

Need for more income

If your purchasing power is decreasing, then you’ll need to somehow earn more money. Many jobs offer annual wage increases that may be in line with inflation, which means if inflation rises by 2% then your salary may be increased by as much.⁴ In that case, you may not feel the impact of an increase in costs as much. If prices increase too rapidly, you may have to consider ways of increasing your income such as asking for a raise or finding higher paying work.

Counteracting inflation

Inflation can also make it more difficult to save. If you’re keeping money in, say, an account that pays 2% interest per year, while inflation rises by 1%, then you’ve made what’s called a 1% real return. However, if inflation rises by 3%, then you’ve lost purchasing power from that account because prices have climbed by more than what you’ve earned.

To counteract rising inflation, you may wish to put your savings to work through investments. For example, many Canadians invest in mutual funds through Registered Retirement Savings Plans (RRSPs) or Tax-Free Savings Accounts (TFSAs) which provides the potential to grow their savings above the rate of inflation. Investments made through RRSPs or TFSAs also offer tax benefits. You can read more about investing through TFSAs and RRSPs here.

If you have trouble getting motivated to contribute, an automatic savings plan, including a pre-authorized purchase plan for your investments, can be an efficient method to increase your savings gradually every paycheque. A financial advisor can discuss the risks involved with investments and what might be appropriate for you based on your specific needs.

At the moment, economists aren’t worried that this heated inflation is going to last.⁵ One reason why inflation climbed so much in May was because the costs of many goods dropped a year earlier as a result of the pandemic’s first lockdown. Supply chain issues throughout the COVID-19 pandemic have also put pressure on supply and demand for certain goods, but TD Economics has said those issues could ease in the coming months. It adds that inflation will remain a bit above 2%, which is in the range that central banks want to see.⁶

As with many aspects of your finances, it’s important to pay attention to the changes in the market but you should be wary of making sudden financial decisions. If you have a solid budget and long-term financial goals you may feel more strongly positioned to weather the effects of inflation. Speaking with a financial advisor may help you adjust to a changing economic climate, make appropriate changes to your activities around money and help you meet your financial goals.