Inflation and Its Impact on the Canadian Economy in 2022

INFLATION AND ITS IMPACT ON

THE CANADIAN ECONOMY IN 2022

Travis Waite, WRLA

As I look out my office window and see the leaves changing colours and falling from trees, my senses steer me towards a period of reflection on the past. With a lot to be grateful for but also a lot of negativities floating around, I ask myself “how did we get here”? Given the whirlwind that society has been through the past few years, it’s a difficult question to answer. The world is attempting to move past the turmoil caused by the COVID-19 pandemic and though there is still clear division, nations continue to recover while striving for a level of normalcy that mirrored pre-pandemic life. If you have kept an eye on the news, you will notice particularly from an economical standpoint, 2022 can be described as anything but “normal”.

Inflation is one of the leading hot-button topics that you have likely heard about endlessly in the news in 2022. It is one that typically strikes fear in businesspeople and consumers alike. Though we may all understand that it will impact our bottom line and wallets, many of us don’t understand what causes inflation, how it is determined, or are confused about what it really means.

We can all see that prices almost across the board are increasing at an unprecedented rate, the cost of borrowing continues to spike, and you’ve probably noticed your investments have taken a major hit. Equities and fixed income investments, which are often used to hedge each other because of high historical correlations in counteracting gains and losses (when one goes up, the other goes down), are both significantly down from their all-time highs in 2021. These outcomes can all be explained as an effect of inflation on the economy. This is not something that is unique to Canadians and is being experienced across the globe.

INFLATION AND THE CANADIAN PRICE INDEX

So, what is inflation? First, we need to understand what the basis of inflation is: the Consumer Price Index (CPI). CPI represents the changes in prices that Canadian consumers experience over time. It is measured using 8 categories of goods and services:

• Food • Shelter • Household operations, furnishing and equipment • Clothing and footwear • Transportation • Health and personal care • Recreation, education and reading • Alcoholic beverages, tobacco products and recreational cannabis

Each of these categories contain various goods and services and are updated frequently to account for changes in Canadian spending habits. Furthermore, increases in prices of these specific items can impact multiple categories of CPI. For example, an increase in gas prices will impact the cost of transportation (to fuel your vehicle), the cost of shelter (to heat and cool your home) and, as we all know, the transportation of goods!

HOW SUPPLY AND DEMAND IMPACTS INFLATION

Supply and demand is another hot-button topic that will affect the consumer price index and as a result inflation. Supply is the amount of a product or service available, and demand is the desire of consumers to buy it.

Due to restrictions from the pandemic, the proportion of consumer spending (demand) over the past few years has shifted away from services like travelling and dining out, towards raw goods. Supply has been unable to keep up with this shifting demand due to labour shortages and supply chain disruptions, causing an imbalance between supply and demand. The result is an increase in prices, thus driving CPI and inflation skyward.

FIGHTING BACK AGAINST INFLATION

In June 2022, Canada saw its annual inflation rate rise to 8.1%, its highest annual increase since January 1983. Factors for this historic increase include higher global demand for energy, driving increases in gasoline prices, surges in food prices, specifically dairy and meat, and the red-hot housing market.

This data has struck fear that a recession is looming. We have already seen the Bank of Canada increase interest rates to 3.25%, which is a 14-year high and they are expected to continue into 2023. These rate hikes are being done in an effort to combat inflation. Increasing interest rates results in a higher cost to borrow money, causing consumers to hold onto their money rather than spend it. This will in turn help lower the consumer price index and bring more balance between supply and demand.

Though there are many external factors driving Canadian inflation (see Russia’s invasion of Ukraine), there are ways as a consumer to help minimize the impact of inflation in homes. Some of these include reducing consumption of items that have risen the most, shopping around and utilizing the second-hand market, and trying to extend the life of your existing goods. Business owners and sales professionals may not be thrilled to hear that consumer spending is the solution to fighting inflation and is trending downward, but this is the unfortunate reality that needs to be taken in order to cool down inflation and the economy.

Ending on a positive note, annual inflation rate growth in Canada has slowed in July and August to 7.6% and 7% respectively per the most recent statistics released. This is an indicator that interest rate hikes are beginning to help slow down consumer spending and though there is still work to be done to get inflation to an acceptable level, the consensus is that June was likely the peak of inflation for this economic cycle in Canada.

With the year-end rate changes set to be announced in December, we’ll soon have a better view of what 2023 has to offer. Make sure to check back to Dollars & Sense in our winter edition for a forecast of the year ahead!