Since the 1980s, inflation has been relatively low and interest rates have steadily decreased. Today, inflation is rising again, at least in the short term.
When the pandemic started, the global economy was shuttered as governments enforced restrictions to help control virus spread. However, mass vaccination programs have led to a gradual reopening, and now experts anticipate robust economic activity amid pent-up consumer and business demand. Along with this economic recovery is an expectation for higher inflation.
Inflation is simply a measure that gauges price movements of goods and services over a period of time. If inflation rises because the price of goods and services has increased, then purchasing power decreases (i.e., things you can buy today at a certain price will cost you more tomorrow – or at some point in the near future).
Inflation and interest rates
Governments and central banks usually try to control the rate of inflation because it leads to a more stable, growing economy. A standard tool for managing inflation is interest rates. When central banks want to curb inflation, they raise interest rates, which dampens the appetite for businesses and consumers to borrow money because of the higher cost of carrying debt.
Given the pandemic’s negative economic impact, governments are willing to let inflation run higher than normal. This will help stimulate the economy and generate tax revenue that can help governments partially cover the enormous cost of fighting the pandemic and supporting the economy. If high inflation is sustained over a longer time period, it will eventually result in increased interest rates.
Handling an inflationary environment
What can you do to offset the effects of inflation and subsequent higher interest rates? How can you take advantage of an inflationary environment? Here are a few actions and strategies to consider, in case of high inflation returns in the near future:
- Reduce non-essential spending: Monitor your spending, reduce or even eliminate certain non-essential expenses, and find ways to keep your costs down. Review your budget (or create one) and your spending habits. Look for ways to reduce monthly costs and save on car insurance, internet, and other recurring expenses.
- Shop smarter and be price-conscious: As prices rise for everyday items (e.g., groceries, personal care products, home-related supplies, clothing/footwear), consider buying non-perishables in bulk to save money, especially if you can purchase them on sale. Leverage online shopping sites to compare prices and benefit from various sales. When it makes good sense, consider purchasing bigger ticket items before a potential future increase in prices.
- Manage your consumer debt: If interest rates appear set to increase – an impending change is typically well communicated by central banks and in the media – consider locking in prevailing low rates for your mortgage, car loan or other debt.
- Pay down debt: If possible, reducing your debt load more aggressively can help manage the negative effects of rising rates on the debt you carry. If interest rates rise because of higher inflation, it will increase the costs of borrowing.
Investment strategies to consider
- Higher interest rates are favourable for savers and will result in more interest earned.
- Diversifying your portfolio may help you withstand a potential period of high inflation, especially if you access certain types of bonds and commodity-related securities that actually thrive when inflation and interest rates are rising.
- Stocks and equity funds typically generate good relative performance when the economy is growing. Also, over the long term, the return on stocks has historically outpaced inflation, allowing investors to build more real wealth to help meet their retirement and other long-term financial goals.
Contact our office to discuss how your financial plan, which includes a diversified investment portfolio, can help protect against – and benefit from – a potential rise in inflation.