The impact of inflation on your family finances goes beyond pricey meat, scary heating bills and kill-me-now moments at the gas pump.
At some point in the next 12 months, the Bank of Canada will start raising interest rates to quell inflation and bring rates back to more normal levels. An inflationary vice awaits – one jaw is higher prices in your day-to-day spending and the other is the rising cost of carrying debt.
The most powerful weapon you have to defend your finances against this squeeze is to pay down your debts. Owe less, pay less.
The inflation report for September cranked up the urgency level a bit for families facing higher living costs. The year-over-year rise in the cost of living came in at 4.4 per cent, the highest in almost 20 years.
Rising inflation increases the risk that the Bank of Canada will have to raise interest rates significantly to cool things down. The central bank has indicated it’s looking at the second half of next year to start the process of retracing the interest-rate cuts used over the past 18 months to defend the economy from pandemic lockdowns.
The latest inflation numbers raise the possibility of a more intense pace of rate increase than we’ve seen in decades. In an updated forecast, Scotia Economics said last week it sees the central bank raising its trendsetting overnight rate four times in the second half of 2022 and another four times in 2023. This would take the overnight rate to 2.25 per cent from the current 0.25 per cent. (The Bank of Canada usually bumps rates higher in increments of 0.25 of a percentage point.)
The Bank of Nova Scotia has some credibility on inflation. Last December, Derek Holt, the bank’s head of capital markets economics, wrote a piece with the headline, Get Used to Rising Inflation in Canada. The year-over-year inflation rate was just 1 per cent back then.
Persistent inflation could also mean rates start rising sooner than next year. The Bank of Canada seems concerned about weighing down the economic recovery from the pandemic with higher rates, but containing inflation is a core mandate for the bank.
Higher interest rates mean you pay more for meat, home heating and gasoline, and to service your floating-rate debt. This includes home equity lines of credit (HELOCs), which are making a comeback as a popular borrowing vehicle as the pandemic eases, as well as unsecured credit lines and floating rate loans.
Variable-rate mortgages are also affected as rates rise. Your payments may stay the same, but more goes to interest repayment and less to paying down principal.
A sense that the Bank of Canada is getting more concerned about inflation would also put upward pressure on fixed mortgage rates, which are influenced by events in the bond market. Government of Canada bond yields have already turned in a hefty increase in the past month or so. If you have a mortgage renewal coming up in 12 to 18 months, it’s reasonable to expect that rates – and your monthly payments – will be higher than they are now.
Pandemic lockdowns offered an opportunity to pile up money in savings accounts for households fortunate enough to have uninterrupted income. Some of this money has been used, but lots remains and is thus available for debt repayment.
With a $50,000 HELOC balance and a rate of 2.95 per cent, your minimum interest-only payment each month is just less than $123. Four increases of 0.25 of a percentage point bring that HELOC rate to 3.95 per cent, which means a minimum payment of almost $165 on that $50,000 balance. Cut that HELOC balance down to $25,000 and you get a minimum monthly payment at 3.95 per cent of about $82.
Paying more for meat and produce? Watching the cost of gas soar while you’re driving more than you have in the past year? Scared to turn on your furnace because of rising natural gas prices?
Paying down debt can clear room in your household budget to pay these costs with minimal pain. In the arsenal of anti-inflation measures available to households, it’s the big gun.
Stay informed about your money. We have a newsletter from personal finance columnist Rob Carrick. Sign up today.
