Prices that go bump overnight

Hey there, time traveller!
This article was published 30/10/2021 (1794 days ago), so information in it may no longer be current.

Forget ghosts and goblins, and maybe even the pandemic. A new monster has emerged to frighten consumers, investors, borrowers, retirees and policymakers alike.

Well, inflation is hardly new.

Yet the spectre of fast-rising prices has surfaced again after lying dormant for a decade or more, conjured up by economic bad mojo brought on by an evil spirit: coronavirus.

In turn, the latest inflation figure from September was the highest in almost 20 years with a basket of goods and services 4.4 per cent pricier than September last year, led by increases in costs for transportation (about nine per cent) and shelter (about five per cent).

Month-over-month, inflation has also been on a steady climb since about last November, driven by a handful of pandemic-related factors.

These include low interest rates that have spurred demand for housing, and a rebound in consumer and business spending amid low supply as manufacturing and commodity production recover. In turn, supply chain bottlenecks have cropped up, leading to price spikes in lumber, energy, microchips and automobiles, to name a few.

Certainly folks are feeling it in their bank accounts and credit card statements too, notes a new report.

BDO’s Affordability Index — released this month — shows the “rising cost of living is taking a huge toll on Manitobans as well as the rest of the country,” says Victoria Doell, a Winnipeg-based licensed insolvency trustee with BDO Canada.

In Manitoba, the survey found about one in three respondents said it’s a challenge to buy groceries. That’s slightly higher than the rest of the nation at one in four.

“Many also have incurred a significant amount of debt, and because of the pandemic, it has had a negative impact on their standard of living because now they have to service that debt-load rather than using that money for their day-to-day living,” she adds.

The index also reveals that 60 per cent of Manitobans believe their standard of living will never fully recover from the pandemic, compared with 49 per cent of Canadians. What’s more, 10 per cent of respondents in the province are “actually carrying balances on their credit cards that never did before,” Doell says.

Of course, inflation isn’t all bad. Nor are the current spikes expected to be a long-term problem, says Jason Heath, certified financial planner at Objective Financial Partners Inc. in Markham, Ont.

“There is a big debate right now to what extent inflation is transitory and temporary, related to the pandemic, or whether it’s high, lasting inflation.”

He adds central bankers — like Tiff Macklem, governor of the Bank of Canada — have consistently stated it’s the former and that inflation will sort itself out as normal returns.

Of all the people who should know what inflation might do next, it’s a central banker. Since the early 1990s, the Bank of Canada, the U.S. Federal Reserve and most other developed economies’ central banks have sought to foster goldilocks inflation — not too hot, and not too cold. For example, the Bank of Canada — as its website states — seeks to keep inflation, as measured by the Consumer Price Index (collected by Statistics Canada), at between one and three per cent, year-over-year.

Obviously, inflation above four per cent is a bit disconcerting even for economic oracles because high inflation can have unwanted knock-on effects such as rising prices for goods and services and higher wages, creating a vicious circle of even higher costs amid slowing economic growth.

In turn, some observers worry rising prices may be a long-term problem, and recent central bank policy — flooding the economy with cheap money via low interest rates to fight the negative effects of the pandemic — is the catalyst for ominous long-term, high inflation.

Then again, runaway inflation fears are hardly new.

“Really, there has been a lot of money put into the economy going back to the financial crisis in 2008-09,” says Grant White, portfolio manager at Endeavour Wealth with iA Securities in Winnipeg.

Too high, or too low inflation “has been a topic on the minds of many economists since 2008,” he adds.

Interest rates have been low, accommodating borrowing and consumption, for more than a decade. That’s a good thing for borrowers and stock market investors. At the same time pensioners, whose incomes are generally fixed, have had to deal with low returns on GICs (guaranteed investment certificates) yielding two per cent or less.

Even without inflation being a problem, these older Canadians, who aren’t working, have seen price growth erode purchasing power.

Consequently the recent spikes are particularly chilling, White notes.

“If your investment is earning two per cent, and inflation is running at four per cent, you have a guaranteed loss of two per cent per year,” he says.

To mitigate rising prices, the classic hedge is stocks, which have fared well during the pandemic and for the better part of the last decade.

As White further explains, central bankers have one key “lever” to tame inflation if it runs amok longer than expected: hiking the overnight interest rate.

In turn, fixed-income assets like bonds would drop in value while stock prices may also fall, at least at first, because the market (most investors) generally considers rising rates to be the end of cheap money, which fuelled stock price inflation in recent years.

Feeling the pinch the most would be borrowers — like first-time home buyers or folks who used home equity to manage overruns.

Still, no one knows what lurks ahead, though it’s likely price increases will moderate.

Then again, another scarier version could materialize: stagflation.

That’s when prices keep rising faster than normal during low economic growth — as experienced in the 1970s.

“There are some people who feel that may be where we’re going now,” says Heath, noting we’ll find out soon enough which expert is correct.

“But it’s kind of hard to figure out as an investor and as a borrower where inflation is going from here.”