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One in four people would not be able to afford a surprise $500 expense, yet the overall level of spending on restaurant meals, travel and jewellery is holding up nicely.

This dichotomy is at the heart of the most important 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 prevailing view is that it could take until early next year, which is difficult to hear if high borrowing costs and inflation are draining your household budget.

The reasons why it’s taking so long to control inflation include wage increases – ironically to offset inflation – and resilient spending on goods and services. Prices go up, people pay up. It’s hard to conquer inflation when that happens.

In a recent edition of its Consumer Spending Tracker, RBC Economics described how spending was holding up despite an increase of 4.25 percentage points in the Bank of Canada’s trendsetting overnight rate in the past 12 months. The average number of restaurant transactions ticked slightly higher in January, travel spending held its ground, and jewellery purchases were the same as a year ago.

Meanwhile, Statistics Canada reported earlier this month on a survey in which 26 per cent of respondents said they don’t have the resources to cover an unexpected expense of $500. There’s always some fuzziness with survey questions like this. Are people saying they don’t have $500 saved? Could they borrow the $500 on a line of credit or credit card?

Let’s just interpret these numbers to mean that one in four people feel pretty desperate about their finances and would be unable to cope with sudden shocks. What they need is for the cost of living to stop rising by about 6 per cent and for the interest rate on their mortgages, loans and lines of credit to pull back from the current peak. Standing in the way of this is resilient spending by some households.

RBC says the interest rate increases used by the Bank of Canada to slow inflation will eventually eat into household purchasing power. The central bank has said it takes 18 to 24 months for rate hikes to take full effect.

There’s a complication, though. The people propping up the country’s consumer spending are also the ones who continue to sit on a hoard of cash saved during pandemic lockdowns.

BMO Economics dug into this cash story in a note headlined “Can Surplus Savings Save the Expansion?” Hope not, the households who can’t cover a $500 expense might be tempted to say in reply.

BMO quotes data showing that net savings shrank 12 per cent for the bottom 40 per cent of income earners between the first three months of 2020 and the third quarter of 2022, while the top 40 per cent increased their net savings by 21 to 34 per cent. This is encouraging for the travel and restaurant industries, not to mention jewellers.

“For retailers, spending on luxury goods and leisure-related services could remain buoyant given the sizable excess savings held by upper-income groups,” the BMO note says.

Spending of any type helps support jobs and wages, so it has real value. But the hard reality of early 2023 is that we need the economy to weaken. That’s the only way inflation will ease enough to allow interest rates to fall.

Bank of Canada Governor Tiff Macklem said as much recently in front of the House of Commons finance committee. For inflation to get back to the bank’s target rate of 2 per cent, “the effects of higher interest rates need to work through the economy and restrain spending enough for supply to catch up.”

The job market is another area where the good fortune of some is hurting others. A wage increase that compensates for the rising cost of living is a big win for your personal finances, but it also fuels inflation.

For now, a lot of households are in a tough spot financially as a result of high inflation and interest rates. Only when the big spenders start pulling back do we have a hope of seeing lower rates and more modest price increases.

Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.

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