Financial Friday #73: What is driving up prices and are they here to stay?

As we emerge from our post-COVID cocoon and start to live life again, one of the most glaring changes has been rising prices – everything seems to be costing a lot more than it did last year. It isn’t just a gut feeling either, the pace of inflation as registered by the Consumer Price Index (CPI) in May was 3.6%, the highest in ten years!

Some would argue the CPI isn’t always an accurate indicator for a given individual and many prices (gasoline for example) dropped during the pandemic, so it's only natural they are climbing higher now. However, if you been out looking for a deal on a new car, purchased some lumber for a home improvement project or filled up with gas, you  certainly don’t need any statistics to confirm that prices are going up!

There are a few theories out there to explain why this is happening. One of the most popular beliefs is that we are experiencing temporary inflation due to a bubble of post-pandemic buying. There is a lot of cooped up demand now being unleashed and as demand surges, prices inevitably rise.

It’s simple supply and demand, which has been exacerbated by the pandemic. Factories were idled and shipping networks were scaled back as demand plummeted, and until they get back up to speed we are seeing some shortages and higher prices for a variety of in-demand goods.

There have also been some industry-specific issues like a shortage of semiconductor chips which seriously reduced new car inventories and is now affecting smart-phone production. Raw material prices are also on the rise. Your local restaurant now has to pay a lot more now for a gallon of cooking oil and that gets passed straight on to you!

However, the idea that recent inflation will be short-lived is not popular among all the pundits. Bank of Montreal economist Douglas Porter warned this week that inflation rates of three, four or five percent could be with us for a year or two.

The issue is that COVID stimulus payments combined with much higher than normal savings rates over the last 12 months (Canadians saved at four times the normal rate during the pandemic) have created a lot of expendable cash that will take more than a few months to work through. Add in a pile of recently retired and affluent baby-boomers looking to spend their retirement nest eggs and you have a lot of money floating around to drive up demand…. and prices.

Is it better to play the waiting game and hold off on that new car or deck project for another year in the hope that prices retreat, or is it time to start stockpiling goods to ward off rising prices down the road?

Unfortunately, we don’t have the answer, other than to say that inflation is here for the time being. Higher prices are going to squeeze household budgets and your investment returns now have some headwinds to overcome.

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