The Consumer Price Index (CPI) and your finances

05 October 2023 by National Bank
Mother and child comparing food prices at the grocery store

Do you know what the CPI is? The Consumer Price Index measures fluctuations in the price of goods and services. As the price of consumer goods rises, you may find yourself under greater financial pressure. Fortunately, there are solutions to help you manage the impact.

What is the Consumer Price Index?

The Consumer Price Index (CPI) represents increases or decreases in prices over time. It’s also one of the variables used to measure inflation and changes in the purchasing power of Canadian households.

How is the Consumer Price Index calculated?

Every month, Statistics Canada fills a basket with 700 common consumer goods and services. They then calculate the variation in the basket’s total cost between one month in a given year and the same month in the previous year.

This basket includes eight categories of goods and services: 

  • Food
  • Shelter
  • Household operations, furnishings and equipment
  • Clothing and footwear 
  • Transportation 
  • Health and personal care
  • Recreation, education and reading
  • Alcoholic beverages, tobacco products and recreational cannabis

Each item is weighted differently based on how much the average Canadian household spends on it each year. For example, since people usually spend more on groceries and housing than on personal care, the weight of the first two categories is greater than the third.

To ensure that the basket reflects the reality and consumption habits of the Canadian population, Statistics Canada revises its contents every two years.

What’s the average inflation rate? 
The Bank of Canada generally tries to keep inflation and the CPI as low as possible. The annual inflation rate usually hovers around 2%.

What impact does the Consumer Price Index have on your finances?

A rise or fall in the CPI can have an impact on your finances. Your purchasing power, savings and investments – especially fixed-income investments such as bonds and savings accounts – could be affected.

Here are five concrete examples to help you better understand the potential effects of these variations.

The impact on your purchasing power

Are prices on the rise? To maintain your current purchasing power, your income needs to increase at the same rate. Otherwise, your purchasing power could decrease and you won’t be able to buy as many goods and services as before.

A drop in your purchasing power can have an impact on your budget and standard of living. The fact is, the higher inflation goes, the lower the value of your income and savings drops.

Let’s take a look at the impact of inflation over a 30-year period on an asset that initially cost $100.

Number of years
2% annual inflation rate
3% annual inflation rate
4% annual inflation rate
5% annual inflation rate
6% annual inflation rate
1 year
10 years
20 years
30 years

There’s a significant difference between the impact of a 2% and 6% annual inflation rate.

On the other hand, if the CPI is falling, you’ll pay less for goods and services. Your purchasing power will increase, and you’ll get more bang for your buck.

The impact on your credit cards, loans and financing

An increase in the CPI can lead to tighter conditions for obtaining loans or credit. Not only can they be more difficult to get, they’ll also come with a higher interest rate.

Here’s an example of how your payments could be affected if the interest rate on your mortgage increases:

  • Mortgage amount: $250,000
  • Amortization period: 20 years
  • Interest rate: 3%
  • If the rate rises to 5%, you’ll have to pay an additional $3,093 per year, for a total of $61,859 until the loan is paid in full 
  • If the rate rises to 6%, you’ll have to pay an additional $4,738 per year, for a total of $94,767 until the loan is paid in full2

Is inflation low or even negative? If so, this will mean lower interest rates, which is an advantage if you need to borrow. However, low or negative inflation can affect your savings and investments, since your returns will be lower.

The impact on your bonds

If inflation rises, interest rates follow suit to compensate for investors’ loss of purchasing power. As a result, the value of your existing bonds may fall.

For example, if someone holds bonds at 2% and new ones are issued at 3%, the bonds at the lower rate won’t be as attractive, causing their price to fall.

The impact on your savings accounts and GICs

When inflation exceeds the interest rates offered on traditional savings accounts, your purchasing power derived from your savings diminishes over time. 

For example, if the CPI is 3% but the interest rate on your savings account is 1.5%, your purchasing power decreases by 1.5%.

How can you avoid the negative effects of inflation on your fixed-income investments? 
You could open a GIC every year, staggering their maturity dates. This way, the GIC with a more advantageous time horizon will make up for the one that is less advantageous. You can also opt for a GIC with a variable return. With this product, capital is guaranteed, but returns will depend on market fluctuations.

The impact on your stocks

Good news: The effects of inflation on stocks are generally less severe than on bonds and savings accounts. This is because companies can raise the prices of their products and services to cope with inflation and stabilize their profits. 

However, high inflation can have a negative impact on demand and production costs. Consequently, it can also affect your stock market performance.

If investing, take the CPI into account when making decisions. This will help you make informed choices to protect your purchasing power and ensure your returns outpace inflation. This advice is even more applicable when it comes to fixed-income investments. If you need advice, talk to a financial specialist.

How can you protect your finances from fluctuations in the Consumer Price Index?

There are several solutions and tools that can help you protect your finances from inflation. Here are a few tips to help you cope.

Make a financial balance sheet

If the CPI fluctuates significantly, taking stock of your expenses and the interest rates on your loans and savings can help you adapt to changing circumstances.

Use our helpful tool to make a financial balance sheet.

Draw up or revise your budget

Don’t have a budget? It’s never too late to make your personal budget. You’ll have a better sense of how much money you have coming in and going out. Already have one? Remember to update it regularly, especially to account for the impact of changes to the CPI. 

You should also revisit your budget every time there’s a major change in your life, such as the arrival of a child, a promotion at work or a sabbatical year.

Use our tool to calculate your budget more accurately.

Diversify your investments 

Diversifying your investment portfolio is key to reducing the risks associated with inflation. This means spreading your investments across different types of assets such as stocks, bonds, raw materials and real estate. 

Regularly review your portfolio

Be proactive and regularly re-evaluate your investments to account for inflation and changing economic conditions. By adjusting your portfolio, you can maximize your returns. 

Make a thorough retirement plan  

To make sure you don’t run out of money when you retire, you need to factor inflation into your calculations. Since inflation could reduce your purchasing power over time, it’s important to anticipate your future income and disbursements to ensure you have enough money in retirement.

Ask the experts 

Not sure of the best strategy for protecting your finances from the impact of inflation? Don’t hesitate to consult a qualified financial advisor. They can help you understand your financial situation and make informed decisions.

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