After four decades of low inflation, the past 24 months have been hindered with elevated inflation, forcing central banks to hike interest rates aggressively. In Canada, the inflation rate jumped from -0.4% in May 2020 to a peak of 8.1% in June 2022. This forced the Bank of Canada (BoC) to hike interest rates to 5% as of July 12, 2023. Inflation currently stands at 2.8%, and the BoC predicts it will reach the 2% target by 2025.
What is inflation?
The BoC defines inflation as “a persistent rise in the average level prices over time”. Key symptoms of genuine inflation are deteriorating price expectations, rising labor costs and broadening of items rising in the CPI basket.
Why is Canada experiencing elevated inflation?
The pandemic caused major dislocation in the production of many goods and services, while also changing the behavior of consumers, such as hoarding, and policymakers, such as expansion of fiscal support. This resulted in much higher inflation. The US and Canada’s rise in prices over the past 24 months have been both a result of supply disruptions caused by the pandemic as well as strong demand stemming from both fiscal and monetary support in 2020 and 2021. In addition, tight labour markets in the U.S. and Canada are contributing to more persistent inflation through higher wage growth supporting domestic demand.
What are the impacts of investing in a time of elevated inflation?
For investors, higher inflation tends to push up the cost of capital, as central banks, such as the BoC, are forced to react to rising prices by increasing interest rates. However, higher rates can offer better opportunities in certain investment classes like fixed income. Meanwhile, persistently rising prices can dampen the purchasing power of households and become a deflationary factor for growth, as seen in the 1970s.
Inflation forecast
Although the target inflation rate is 2%, we expect the U.S. and Canada to average a 3.5% and 3.4% inflation growth rate over the next 12 months. Despite progress in bringing inflation back down, tight labor market conditions and more fiscal support for the economy will keep inflation persistently higher. When it comes to managing your money, expect the cost of goods and services to continue to rise. Investors should expect continued volatility in financial markets, which may be reflected in your portfolio. It’s important to stay invested for the long term and avoid letting temporary market conditions impact your investment strategy.
