Canada’s inflation rate fell to 3.1% in October—where will it go from here?

Some relatively good news about your grocery bill: Grocery inflation remained high in October, but the overall trend is positive, with the rate for groceries falling to 5.4%, down from 5.8% in September. The speed at which grocery prices are rising has slowed for the last four consecutive months—a trend economists refer to as a “deceleration” of prices. But many Canadians will continue to look for ways to save on groceries and other household bills.

Higher mortgage interest costs also contributed to October’s inflation reading. At 30.5%, mortgage interest costs are the biggest contributor to the 12-month change in the CPI. Canadians with variable-rate mortgages see their mortgage costs increase with every jump in the BoC’s benchmark interest rate, and many Canadians with fixed mortgage rates are now renewing their mortgages at higher rates. These two factors are contributing substantially to the rate of inflation in Canada.

What does inflation mean? 

Inflation is the rising cost of goods and services, which leads to a decrease in the purchasing power of money. 

Say you have $10. Last year, a can of tomato sauce cost $5, so you could afford two cans. But the cost per can has risen to $6.50, which means now you can only afford one. Over time, you’ll be able to purchase fewer and fewer things with the same $10 of income. When your income growth does not rise in sync with inflation, your purchasing power erodes and your standard of living decreases.

What is a good rate of inflation? 

Some people may think we should aim for 0% inflation. However, most economists, the BoC and other central banks see some inflation as desirable and reflective of a healthy economy. The BoC manipulates the Canadian money supply, as well as interest rates, to maintain a target rate of 2% inflation—or between 1% and 3%. 

Inflation lower than 2% suggests there is an excess of supply, which means the economy is struggling; this leads to less production and fewer jobs. 

Inflation higher than 2% signals that the economy is growing too quickly. Typically, this means Canadians are earning too much income—between their jobs, government benefits and other sources—and snapping up goods so fast that there are supply shortages, and therefore rising prices. 

Why is inflation so high in Canada? 

One of the reasons inflation is so high in Canada is because the federal government and the BoC worked together during the pandemic to increase the amount of money in circulation. The federal government spent north of $500 billion on pandemic-related benefits in 2020 and 2021, largely financed with bonds the BoC purchased. Canadians’ savings rate skyrocketed and the median after-tax income increased 7% from 2019 to 2020, largely thanks to these programs.  

Worried about deflation because of how many Canadians were losing their jobs due to lockdowns, the BoC decreased the key interest rate to a historic low of 0.25% to encourage investing and spending. At the same time, global events, such as the war in Ukraine and China’s COVID-zero policies, created supply shortages for commodities like grain and oil and reduced global production.

Excess money in the economy plus fewer goods equals rising prices. 

When will inflation go down in Canada? 

In its October projection, the BoC said it expects inflation to average about 3.5% through to the middle of 2024. At that point, the Bank believes CPI inflation will gradually decline and return to the 2% target in 2025. The BoC had predicted a similar path to the target rate in its July projection; however, it now anticipates the rate to remain higher in the near term because of “energy prices and ongoing persistence in core inflation.”

How does inflation affect my investments?

Inflation erodes the profit you make on an investment.

Let’s say you purchase a stock that rises 5% in one year. Your “nominal” rate of return before factoring in any fees, taxes or inflation is 5%. But if inflation rises 2% that same year, your “real” rate of return is only 3%. It’s important to calculate your investment profit using a real rate of return so you can properly evaluate where to put your money. (Find out how inflation might affect your retirement investments.)

As a rule, it’s difficult to make a profit with any investment during times of high inflation—your purchasing power decreases faster than most investme,nts can grow. But some investments are more resilient against inflation than others.

Stocks

Inflation can negatively affect the stock market, because rising costs and interest rates usually affect companies’ bottom lines. Investors are also psychologically hesitant to put money in the markets if they feel it’s too risky, which further contributes to market drops. But this scenario can also provide an opportunity to buy high-quality, large-cap companies at a slight discount. 

Bonds

When inflation rises, bond prices fall, and vice versa. That’s why long-term bonds can be a tricky bet. A short-term bond, however, such as a one-year bond, can be a good place to park money during high inflation, until it’s clearer where inflation and interest rates are going. 

GICs

Guaranteed investment certificates (GICs) may appear to be a good deal during times of high inflation. In 2022 and early 2023, for example, you could get GICs with rates around 5%, higher than the 1% or so offered in recent years. That may sound great, but when you consider that inflation remained between 5% and 8% during that period, you could have a negative real rate of return. Nevertheless, GICs are a reasonable alternative for low-risk investors who would otherwise leave their money in cash. (See what the rates are like now, by clicking below.)

ETFs

Exchanged-traded funds (ETFs) are a basket of assets, usually stocks, bonds or a combination thereof. Canadian investors can choose from a wide range of ETFs, with varying levels of performance and risk. Broad-based market ETFs tend to be a conservative and easy choice for investors during all market cycles, if they are willing to hold for the long term.

What to expect in 2024 

The BoC is determined to bring inflation back down to 2%. Recent CPI readings indicate inflation is cooling and moving toward the BoC’s 2% target, but the long-term outlook remains uncertain.

Frequently asked questions

Read more about inflation:

• Compound interest calculator: How interest grows
• What does high inflation mean for your retirement savings?
• What the Bank of Canada’s latest overnight rate hike means for your finances
• A contrarian approach to inflation, interest rates and the markets

About Danielle Kubes

Danielle Kubes is a freelance journalist living in Toronto. She has a master’s degree in journalism from Toronto Metropolitan University.

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About Justin Dallaire

Justin Dallaire is the senior editor at MoneySense.ca. He was previously an editor at Strategy magazine and has a master’s degree in journalism from Toronto Metropolitan University.

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