How has the Bank of Canada responded to inflation?
Between March 2022 and July 2023, the BoC raised its key lending rate from 0.25% to 5%, with the goal of slowing price growth and reaching its 2% inflation target. Now that inflation has slowed, it’s not clear when the BoC will adjust the benchmark rate. Many economists expect to see rate cuts at some point in 2024.
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 investments 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
Exchange-traded funds (ETFs) are a basket of assets, usually stocks, bonds or a combination of the two. 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.
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