Canada Savings Bonds, now discontinued, had a decades-long run as a reliable way to save money safely. But CSBs were never better than ’81, a year when out-of-control inflation hit 12.5%. Inflation is running at 8.1 percent today in Canada and reached 9.1 percent last month in the United States. But the best rate you can get for safe savings is 3 percent on a high-interest savings account and about 4 to 5 percent on a guaranteed investment certificate. There is a strong argument against saving today as the return after inflation is negative. Don’t pay attention to it. By saving – or more specifically, not spending – we help reduce inflation and the need for the kind of shock rate hikes we saw last week. When the Bank of Canada raised the overnight rate by a full percentage point to 2.5%, it was the biggest increase in that benchmark since 1998. But it’s the early 1980s that seem more relevant to today’s world of high inflation and rising rates. Think of this moment as an example of what happens if we don’t quickly get inflation under control. The early 1980s brought the peak of the soaring inflation of the 1970s, says Mike Moffatt, an economist and adjunct professor at the University of Western Ontario’s Ivey Business School. The central bankers of the day had to respond with enormous force, which meant raising their benchmark interest rates into the financial stratosphere. The Bank of Canada’s trend rate reached 21 per cent in 1981, and the prime rate used by the big banks for elite borrowers peaked at 22.75 per cent. The current prime is 4.7 percent. The recent rate hikes by the Bank of Canada are an attempt to contain inflation before it becomes embedded in the economy as it did in the 1970s, Professor Moffatt said. “Inflation is kind of built up if you expect prices to go up 7 or 8 percent a year,” he said. “You’re not going to save money – you’re going to go out and buy stuff straight away. Because the longer you wait, the more prices will go up.” The Bank of Canada has been criticized for treating inflation as temporary for too long and thus delaying a return to more normal interest rates from pandemic lows. However, last week’s outsized rate hike shows a commitment to aggressively tackle inflation. Professor Moffatt said a large part of our inflation problem was caused by high energy and food prices linked to the war in Ukraine and supply chain issues related to the pandemic. But he also sees signs of an inflationary mindset in the population. “There seems to be this kind of belief that inflation is here to stay and I think it’s making people look at their behavior – asking for pay rises and things like that,” he said. It’s up to the Bank of Canada, not you, to create conditions where people don’t have to ask for a big raise to keep up with the cost of living. But the world of 1981 reminds us of what happens when inflation drives our economic behavior. One-year mortgage rates hit 21.25 per cent in the summer of 1981, Bank of Canada records show. In addition to this jumbo CSB rate, a top yield of 18.8 per cent was available from five-year Government of Canada bonds. The result of such high interest rates was that inflation and, in turn, interest rates themselves fell. Note the lesson here for savers in an era of high inflation. The higher the interest rates on bonds and GICs, the greater the reward for buying them and locking them in for as long as you can. However, the moment of opportunity may not last. “I think there will be a peak for rates, not a plateau,” Professor Moffatt said. “We will reach some level where the risk of inflation will recede and then interest rates may come down slowly. Anyone who locks in and buys a five-year or 10-year bond at the peak will do very well.” Are you a young Canadian with money on your mind? To set yourself up for success and avoid costly mistakes, listen to our award-winning Stress Test podcast.
