Wealthy households fuel the inflation which makes life unaffordable for others

Despite the fact that one in four people would be unable to pay a sudden $500 expense, overall spending on dining out, travel, and jewelry is still at a healthy level.

This dichotomy is at the core of the most crucial economic and personal finance question of the moment, which can be summed up as follows: When will inflation ease enough to allow interest rates to come down? The conventional wisdom is that it could take until early next year, which is difficult to hear if high borrowing costs and inflation are depleting your household budget.

Wage increases, which ironically serve to counteract inflation, and resilient spending on goods and services are some of the factors contributing to the prolonged inability to control inflation. People pay more as prices rise. When that occurs, it is challenging to defeat inflation.

The Bank of Canada’s trendsetting overnight rate increased by 4 points, 25 basis points over the previous 12 months, according to RBC Economics’ most recent Consumer Spending Tracker, which examined how spending was holding up in that time. In January, the average number of restaurant transactions edged up a little bit, travel spending stayed steady, and jewelry purchases were unchanged from a year ago.

In the meantime, 26% of respondents to a survey published earlier this month by Statistics Canada said they lack the funds to pay a $500 unexpected expense. These types of survey questions always have some degree of fuzziness. Are people claiming they don’t have $500 in savings? Could they use a credit card or line of credit to borrow the $500?

Let’s just take these statistics to mean that one in four people feel pretty desperate about their finances and would be unable to handle unexpected shocks. What they require is for the cost of living to stop increasing by roughly 6% and for the interest rates on their mortgages, loans, and credit lines to decline from their recent highs. Resistant spending by some households is preventing this.

The Bank of Canada’s interest rate increases, according to RBC, will eventually reduce household purchasing power by slowing inflation. Rate increases must be fully implemented within 18 to 24 months, according to the central bank.

However, there is a difficulty. The people who are maintaining the nation’s consumer spending are also the ones who are still holding onto a stash of money that was saved during pandemic lockdowns.

In a note titled “Can Surplus Savings Save the Expansion,” BMO Economics examined this cash-related topic. “Hope not,” might be the response from households that are unable to pay a $500 expense.

According to data cited by BMO, between the first three months of 2020 and the third quarter of 2022, net savings for the bottom 40% of income earners decreased by 12%, while net savings for the top 40% increased by 21 to 34%. This is encouraging for the hospitality and travel sectors, not to mention jewelers.

Given the sizeable excess savings held by upper-income groups, the BMO note states that spending on luxury goods and leisure-related services “could remain buoyant for retailers”.

Spending has real value because it supports wages and jobs. However, we must allow the economy to deteriorate in order to avoid the harsh reality of early 2023. Only in this way will inflation subside sufficiently for interest rates to decrease.

Tiff Macklem, the governor of the Bank of Canada, recently made this statement in front of the House of Commons finance committee. The effects of higher interest rates must spread throughout the economy and sufficiently curb spending for supplies to catch up in order for inflation to return to the bank’s target rate of 2%. “.

Another area where the good fortune of some is harming others is the job market. Your personal finances will benefit greatly from a wage increase that offsets the rising cost of living, but it will also increase inflation.

Due to high inflation and interest rates, many households are currently experiencing financial hardship. We only have a chance of lower rates and more gradual price increases once the big spenders start cutting back.