Interest Rate Hikes Affecting Your Personal Finances? You Are Not Alone

Prices for almost everything have gone up a lot over the last year. Canadians have also faced interest rate hikes from the Bank of Canada, and according to economists, we can expect more in the near future. Understanding inflation, its causes, and the role the Bank of Canada has in controlling it can help you reduce its impact on your personal finances.

Inflation and Interest Rate Hikes

Inflation is the measure of a price increase in the cost of the same item over time. Your cash doesn’t go as far as it used to, which means a decrease in purchasing power. Your favourite loaf of bread may have cost you $2.79 a year ago, but now you are paying $3.06 for the same loaf of bread. The higher price represents a 10% price increase, or 10% inflation for that loaf of bread.

If your income or wages don’t go up at the same rate as inflation, you could fall behind financially. Inflation can have a big impact on your cost of living by making everything you need to buy more expensive, reducing the amount you can save and increasing your debt payments.

Causes of inflation

Several factors can cause inflation. It’s often a result of a number of economic conditions coming together at once, causing prices to rise. Canada’s inflation may be partly due to rising energy prices, supply chain disruptions, and pent-up consumer demand from a two-year pandemic.

How inflation is measured

Inflation is tracked monthly in Canada by Statistics Canada. They do this by monitoring the cost of a basket of goods typically bought by the average Canadian consumer. Each item in this basket of goods has a price. The price is added and then averaged to form the Consumer Price Index. Things that Statistics Canada includes in the Consumer Price index are:

• Shelter
• Food
• Clothing and footwear
• Health and personal care
• Household operations
• Furnishings
• Transportation
• Recreation

Ideally, the Bank of Canada wants inflation to be between 1-3%. However, their target rate for inflation is 2%. Keeping inflation low helps money retain its value, and the predictability of a low inflation rate helps consumers plan when, where, and how to spend their money.

When inflation is too high, it reduces the purchasing power of your money. You can’t buy as much as they did before. As a result, it can be difficult making ends meet. Businesses and investors may stop investing or expanding because of the unpredictability of inflation. By keeping the inflation rate low, economies avoid the problems of reduced purchasing power and less economic activity.

How rising interest rates slow inflation

The Bank of Canada will often respond to inflation by increasing the prime rate. The prime rate is a base rate that is used to negotiate floating rate loans. It’s also the rate that the most credit-worthy business customers are charged by commercial banks.

The Bank of Canada has made two interest rate hikes in 2022 in an effort to avoid the negative economic consequences of rapid inflation. So, how does this work? Interest rate hikes are meant to discourage borrowing and encourage saving. If interest rates on loans, lines of credit, mortgages and credit cards are too high, most of us will be more cautious about using them. We may choose to save our money instead, especially if we can get a good rate on our savings or investments.

When consumers decide not to borrow or choose to save more, they buy less. Buying less can slow down the pace of inflation. When we aren’t spending as much, businesses tend to reduce their prices or to raise them at a slower pace in order to sell their products and services.

How Inflation Affects Your Finances

Inflation affects your finances by reducing your purchasing power making budgeting harder. You might find inflation is putting you in a position of having to make tough choices, like whether to pay the rent or buy groceries. In addition, payments on any variable rate credit products you have will go up too, putting more stress on your budget.

Inflation and your cost of living

As we have seen, energy costs, consumer demand, and supply chain issues contribute to inflation. Canada’s current inflation rate is 7.70%. As the costs for raw materials, supplies, and transportation rise, the price of goods and services increases as businesses pass on their costs to the consumer.

As prices go up, you may find it harder to make ends meet. If your income has not kept pace with inflation, your money might buy less of the things you need and you could find it harder to save or invest. As a result, you might be cutting back on your purchases, using savings to buy necessities, accessing your credit cards to cover shortfalls or having a difficult time making debt payments.

How interest rate hikes affect debt repayment

Any money you owe on credit products tied to the prime rate will cost more too. These typically include variable rate mortgages, personal lines of credit, home equity lines of credit, and variable rate loans. You will notice your payments are higher because your rates on those products are tied to the prime rate. As the prime rate increases, the rates on these products increase which, in turn, increases your payments.

With inflation reducing your purchasing power and increasing your debt payments, you may feel overwhelmed and unable to manage your cost of living and borrowing expenses. A Licensed Insolvency Trustee (LIT) can advise you on options for debt relief.

How an LIT Can Help You

An LIT can offer valuable assistance in helping you manage your debt. They can give you debt relief options to help you get a fresh start. The Canadian government licenses and regulates LITs after they have met the  educational requirements and obtained the necessary credentials. In addition, LITs have a fiduciary duty to act in the best interest of their clients so you know they will be offering you the options best suited to your situation.

For a free, no-obligation consultation, call Adamson and Associates at 519-310-JOHN (3546). We can help you manage your debt and take control of your finances in these unprecedented times.