Inflation, interest rates and saving — some top tips for coping

While the COVID-19 pandemic is waning and society is awakening, now Canadians must deal with inflation at its highest level since the early 1990s.¹ Prices have risen for several reasons including supply and labour shortages, climate change impacts on food, and government spending such as income supplements.

Like in other countries, Canada’s central bank is raising interest rates to fight inflation. But it can take a while for price increases to slow. Meantime, consumers must contend with the end of some government aid, lower buying power and more expensive mortgages.

“People will be back in these very difficult circumstances that they find themselves and so it's very tough for people at the lower end of the income spectrum,” says Bruce Sellery, personal finance expert and chief executive officer of Credit Canada Debt Solutions. “People, even if they're higher income, are carrying a significant amount of consumer debt."

The inflation rate in Canada has reached 30-year highs, but it often feels much higher.²  We can all see food prices rising in grocery stores, renovations getting more expensive and car prices climbing. That's simply what happens after interest rates were at historic lows and billions of dollars of new money entered the economy. There's nothing the average Canadian can do about the causes of inflation.

“For us as Canadians complaining about inflation, it makes no difference," Sellery says. “Even talking about inflation makes no difference. It's like talking about the weather, right? Just go shovel your driveway already."

With that dose of reality, Sellery suggests controlling your cash flow as tightly as possible. There are two factors that make inflation painful: rising expenses and a stagnant salary. You must tackle it on both fronts to make headway.

On the expense side, what changes can you make to improve your financial well-being? Can you buy no-name products? Can you hold off on some purchases? Can you choose in-season produce instead of strawberries in February?

On the salary side, it's time to start advocating for yourself. Thankfully, the labour market is hot. It may be time to ask your boss for a raise or brush up your résumé. Perhaps you can also take on overtime or hustle for additional clients.

“We can influence income and we can control our expenses,” Sellery says.

If you don't know where to start when it comes to controlling your finances, Sellery's Priority Pyramid can point you in the right direction. It is a system that helps you set your financial priorities. There are six levels in the Priority Pyramid. Once you have control over one level, you can move up to the next.

Part of the reason inflation is so high is because interest rates have been so low. The central bank says it plans to raise rates several times to fight inflation. Debt is becoming more expensive.

Canadians are deep in debt. We have taken on $193 billion in new mortgage debt during the pandemic, advancing total household debt to a record $2.5 trillion.³ The volume of new home-equity lines of credit is also the highest it's been in a decade.⁴

Now, this isn't necessarily a problem. The mortgage stress test begun in 2018 qualifies homeowners for an interest rate at two percentage points above their contract rate, meaning most borrowers with a job should be able to handle a rate increase. And even when rates rise, variable rate mortgages have stable monthly payments. They will just end up taking longer to pay off.

The people who need to think most about debt right now, according to Sellery, are those who are considering a new home this year. They should be thinking five years out so when they renew, they can predict what that rate will be and how they plan to pay for it.

Interestingly, at the same time as mortgage debt exploded, consumer debt actually fell.⁵ Sellery says that in his line of work at Credit Canada, he has seen fewer Canadians enter debt consolidation programs or consumer proposals with the speed and volume that they would have a couple of years ago, largely due to the stabilizing effect of government pandemic benefits.

However, Sellery expects this effect on personal finances is only short-term because the benefits are winding down, if not entirely gone. “We predict that in short order those numbers will increase, and our phones are going to ring off the hook," he says. For those who still have substantial amounts of consumer debt, it's important to plan to pay it off as soon as possible.

When restaurants, hair salons, theatres and malls were closed during the pandemic, Canadians found out just how simple it was to save when they weren't leaving the house to spend. Government pandemic benefits also helped. Canadians stashed away an incredible $212 billion during the height of coronavirus in 2020 versus $18 billion in 2019. That works out to an average of $5,574 per Canadian in 2020, compared to $479 in 2019.

If you didn't have an emergency fund before the pandemic, now is the time to start building one as society opens up. Sellery suggests opening a separate bank account to store money for unpredictable expenses.

“I would love for every single Canadian to know in their bones the importance of having access to cash, in either emergency savings or access to it in a different way," Sellery says.

Let's say your monthly expenses total around $5,000. You should aim to have at least $15,000 in easily accessible cash. That may sound like a lot, and it will certainly take time to build, but it's possible. Even if you can only save $100 a month, it's a start.

Putting aside cash equal to three to six months of expenses not only helps you sleep better at night, but it also prevents you from going into debt should we be struck by another pandemic, or any emergency. 

While many people feel secure having a reserve of funds in a savings account it's not necessarily right for everyone. With interest rates still low in historic terms and inflation high, any cash sitting in a bank account loses purchasing power. Some Canadians believe it can be better deployed, such as by investing in a TFSA. Instead of accessing a savings account in an emergency, these Canadians would prefer to use a revolving line of credit.

If you're particularly money-savvy and have otherwise strong financial health with good retirement savings, this is certainly an option to consider.

“There's a real difference in temperament, so some people look at that, you know, let's say it's 10 grand or 20 grand or five grand," Sellery says. “Some people look at that and think, 'OK, at least I know if I lose my job or you know something big happens, I've got that insurance in that fund,' and other people are annoyed that that money isn't working for them."

Typically, a line of credit has favourable interest rates. That's because it's tied to your house, or a financial institution offers it to longstanding clients with high credit scores who have substantial savings. It's simple to access in an emergency and you can choose to only pay off the interest. If you have an emergency, you can take on debt at low rates as you need to.

However, a line of credit presents more risk. It requires higher financial literacy with debt management. If you have other financial stress, such as high student loans, a low-wage job or an unpredictable career, you should stick to a typical emergency fund.

It's easy to say no one saw the coronavirus coming, but experts in health care were warning about a global pandemic for decades. And if not a pandemic, it might have been another emergency. The point? With good financial habits we can be prepared for the unexpected.

Proper wealth management requires having a good handle on your cash flow, a healthy emergency fund and minimal debt – or at least debt at very low interest rates (i.e., not credit card debt).

Most of us need a little help with this. Connect with a Scotiabank advisor to get simple step-by-step guides to financial planning, investing, budgeting and more. An advisor can help you feel in control, lessen your stress load and guard against the unexpected.