What the return of inflation will look like for wages, debt and savings

Writing in the Financial Post, noted financial writer Jason Heath takes a look at what the return of inflation will mean for us.

He reports that in February, the consumer price index (CPI) jumped by 5.7 per cent, which “is the biggest increase since August 1991, when inflation was six per cent.”

Since that long-ago peak, he writes, inflation has fallen to much lower levels. Over the last 30 years, it has averaged 1.9 per cent, Heath explains. And, he adds, the Bank of Canada over the intervening years has put policies in place, as required, to keep the brakes on inflation.

Managing inflation through central bank policy is a lot like turning around an ocean liner – you have to make small adjustments over a long time frame. For interest rates, corrective action takes place “typically within a horizon of six to eight quarters,” or a year and a half to two years, he writes.

Despite that effort, our old friend is back, and not just here in Canada. Inflation rates are at 7.9 per cent in the U.S., 6.1 per cent in India, and at 5.9 per cent in the “Eurozone,” he writes.

He then takes a look at its likely impacts.

Higher wages: First, he writes, employers need to look at wage increases. Hourly wages have increased by just 1.8 per cent since 2020. “If inflation remains persistently high, workers whose earnings cannot keep up with the rate of inflation are effectively getting a pay cut,” he notes. They’ll need more wages to pay for the higher price of goods and services, he explains.

Higher interest on debt: If you are carrying a lot of debt, higher interest rates will cut into your cash flow, he writes.

“That cash flow decrease may not be immediate but many mortgage borrowers will see their amortization period increase as more of their monthly payments go to interest and their debt-free date is delayed. This is an important consideration for young homebuyers if they are going to balance their home ownership goals with other priorities like retirement,” he writes.

Even an increase of two per cent in borrowing rates, Heath explains, could add 13 years to your mortgage if you don’t change your monthly payment amount.

Inflation protection for retirees: Heath points out that government pensions – the Canada Pension Plan and Old Age Security – are indexed, and are increased annually based on the rate of inflation. This, he says, is a “powerful” hedge against inflation.

Interest rates are a consideration for those living on savings. If interest rates on your investments don’t keep up with inflation, it will take less time for your portfolio to decline to zero. But if interest rates are higher than inflation, you may still have tens of thousands of dollars in savings 25 or 30 years after you start drawing down your savings.

“In the short run, higher inflation is concerning and can lead to uncertainty. The Bank of Canada is likely to continue to increase interest rates to counter the higher cost of living. There is a risk the rate increases have taken too long to start or may now happen more quickly than expected, and that may have implications for savers, retirees, the economy, and the stock market,” he concludes.

Save with SPP was a youngish reporter in 1991, and remembers that the guaranteed investment certificate (GIC) was still a big tool in one’s investment portfolio in those days, as was the Canada Savings Bond. While interest on such products had been double digit a decade earlier, it was still nice to get five or six per cent interest each year without having to invest in riskier stocks or equity mutual funds.

And while it is exciting to imagine our wages going up by five per cent or more, it is rendered less exciting when the cost of everything is also going up. It was strange, on our recent trip to Whitby to see our new grandbaby, to be “excited” to find gas at the pump for under $1.70 per litre.

What’s a retirement saver to do? If you are following a balanced approach, with exposure to multiple asset classes, you should fare pretty well in a challenging investment environment. An example of that is the Saskatchewan Pension Plan’s Balanced Fund. It has eight distinct and different investment categories in which to place your savings “eggs,” including Canadian, U.S. and Non-North American Equity, Bonds, Mortgages, Real Estate, Short-Term Investments and Infrastructure. If one category is having challenges, it is quite likely that others are performing well – that’s the advantage of a balanced approach. Check out SPP today!

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Before the pandemic, we read countless stories about how the savings rate among Canadians had fallen to its lowest level in decades.  Now, possibly due to the fact that the pandemic has limited our ability to spend money, the opposite is now true. We are reaching the highest personal savings rate we’ve experienced in 35 years.

According to a report in the Toronto Star, Canadians in 2020 “saved a greater chunk of their income than they had in three and a half decades.”  Canucks put away 14.8 per cent of their income last year, representing about $5,000 per person in savings.

“People weren’t able to spend on a lot of things they normally can, because of the lockdowns. And in some cases, they chose not to spend,” Pedro Antunes, chief economist at the Conference Board of Canada, tells the Star.

Save with SPP can still remember 1981, but at that time, working as a cub reporter, one’s focus was not on the long term, or savings. So, we had to check back to see what it was like the last time we had a high national savings rate.

At RatesDotCa, there’s a nice article that recaps what it was like 40 years ago for Canadian savers.

For starters, the article notes, interest rates were the opposite of what they are today – at all-time highs.

“If you’re not old enough to remember the recession of the early 1980s, your parents certainly will. In 1981, mortgage rates peaked at more than 20 per cent,” RatesDotCa reports.

“Many people whose mortgages were up for renewal during that period found themselves signing up for mortgage rates that were twice as high as they were just five years prior. Some resorted to paying hefty upfront fees to get private lenders to offer them rates in the mid-teens,” the article continues.

Other things – most goods and services – kept going up. The Inflation.eu website shows that throughout 1981, the consumer price index went up by more than 12 per cent. While your pay tended to go up to address higher costs of living, it usually didn’t go up as fast as prices did.

Save with SPP recalls getting a car loan at 16 per cent interest from CIBC. The effect of the high cost of borrowing was that we got a little used Plymouth Horizon – a little car for a big interest rate. Today, it’s the opposite – people are getting big houses and cars because it’s a low interest rate.

But we also recall the benefit of high interest rates on our savings back in the early 1980s. You could get a Canada Savings Bond that paid double-digit interest. It was the same story with GICs. Your parents and grandparents were probably chiefly buying interest-paying investments in those heady days. It was a thing, and payroll Canada Savings Bonds were commonplace.

Recently, we have begun to hear that our historically low interest rates may be on the rise once again.

The Globe and Mail reports that inflation went up 1.1 per cent in February, and one per cent in January. Rising gas prices are part of the upward push, the article notes. The Bank of Canada, the article notes, is expecting a 1.7% rate of inflation this year.

Will inflation hikes bring with them interest rate hikes – a return to the 1980s? It’s unlikely, says RatesDotCa.

“Although it’s unlikely that rates will hit the likes of 15-20 per cent again, we may very well see 5-7 per cent in the long run. That type of a jump may still be two to three times higher than your current mortgage rate.  Do you think you could afford paying nearly three times as much as you do today for your mortgage, and still afford those other essentials like heat and groceries,” the article warns.

The takeaway here is that things change. We have had low interest rates for so long, only us greybeards remember when we didn’t. Will savers start to pile into interest-bearing investments once again if rates begin to tick upwards? We’ll need to wait and see.

A balanced approach makes sense when you are saving for the long term. When interest rates are low, other investment categories – Canadian and international equities, real estate, and so on – tend to do better. But when you’re in a balanced investment fund, the experts are the ones who figure out when to rebalance, not you.

The Saskatchewan Pension Plan has a Balanced Fund that invests your contributions in Canadian and international equities, infrastructure, bonds, mortgages, real estate and short-term investments. All this diversity at a management fee of just 0.83 per cent in 2020. Put your retirement savings into balance; why not check out SPP today?

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Much is said and written about the need to get more people to save for retirement, particularly younger folks who typically lack a retirement program at work.

According to David Herle, Principal Partner at research firm The Gandalf Group, and a noted political and retirement commentator, it’s not just younger people who aren’t saving for retirement.

“We know that young people do not think about the end state of their lives,” he tells Save with SPP in a recent telephone interview. “They are focused on their more immediate needs.” Those needs include the cost of education, housing, and consumer debt.

When talk turns to millennials, the Saskatchewan-born Herle points out that their ability to save is hampered by the fact that there are “less jobs, and specifically, less good jobs with pensions and benefits” in today’s “gig economy.”

So not only are young people not saving, neither are old people. No one, he explains, has any extra money kicking around to save for retirement.

Herle says his firm’s research has shown repeatedly that the best way to get people to save is to make it mandatory, with no way to opt out. That way, he says, ensures money is directed to their long-term savings without the individual “having to think about it.”

Otherwise, he notes, getting people to save is challenging. “There’s not a lot of benefit from lecturing people,” he explains.

Asked if there are any public policy options to increase savings, Herle noted one idea from the past that could be revisited – payroll Canada Savings Bond purchases.

In the recent past, you could buy a Canada Savings Bond and pay for it via payroll deductions, a sort of “pay yourself first” option that did encourage some savings. “It might be worth considering bringing it back,” he suggests.

He points to the expansion of the Canada Pension Plan as “the most significant public policy development” in the retirement savings space. Ontario considered bringing in its own pension plan to supplement CPP, but the Ontario Retirement Pension Plan was shelved when CPP expansion got the green light a few years ago, he says.

The other trend he calls “troubling” is the lack of good pension plans in the workplace. For many years most people had a decent pension plan at work, the defined benefit variety which spells out what your retirement income will be. But employers “have started cutting pension plans,” moving to other arrangements, such as group RRSPs or capital accumulation plans where future income is not guaranteed.

He cites the recent labour dispute over pensions involving Co-op Refinery workers in Regina as an example of an employer trying to cut pension benefits for their employees. “If this happens, we could be seeing the end of the line for pensions,” he warns.

“Most people have lost the security of having an employer-sponsored pension plan,” Herle explains. There’s a large chunk of “middle and low-income earners” who are being expected to compensate for the lack of a plan at work with their own private savings.

“Our research found that those aged 55 to 65 – and this is not counting real estate – have more debt than savings. So this is people in the 10-year run-up to retirement,” he says. The lack of savings will force people to use home equity lines of credit, and the “reverse mortgage business is going to take off.”

Debt is restricting the ability to save, and CPP changes “won’t kick in in time for many people.” Herle says he has not heard of any plans to fix the other pillar of the federal retirement system, the taxpayer-funded Old Age Security program. Recent governments have tried to raise the age of entitlement, and a clawback program is already in place to reduce OAS payouts for higher income earners.

The outlook for retirement saving is “a very gloomy picture,” Herle concludes. He blames “a systematic societal failure… where the risk (of retirement investment) has been transferred to employees from employers.”

We thank David Herle for taking the time to speak to Save with SPP, and encourage readers to check out his podcast, The Herle Burly.

It’s true that paying yourself first – directing something to savings and then spending the rest – can work, especially if it is an automatic thing and the money moves before you can spend it. The Saskatchewan Pension Plan has flexible contribution options that include a direct deposit program; you can set it and forget it. SPP also has an option for employers to set up an easily administered pension plan for their employees. Check them out today!

Written by Martin Biefer
	Martin Biefer is Senior Pension Writer at Avery & Kerr Communications in Nepean, Ontario. A veteran reporter, editor and pension communicator, he’s now a freelancer. Interests include golf, line dancing and classic rock. He and his wife live with their Shelties, Duncan and Phoebe, and cat, Toobins. You can follow him on Twitter – his handle is @AveryKerr22