After five years of spending more than they earn, Canadians are beginning to spend less and save more, and this trend will likely continue for years to come, according to a new report by TD Economics.

The report, called Shift to Thrift, calls for the personal savings rate to rise to a new long-run average of 6% to 7% in the next five years.

This contrasts with a savings rate of 2.9% in the five years ending in 2008, when households overspent relative to their income, became over extended with debt and saved too little. During the same period, real personal consumption grew at an average annual pace that was more than one-third faster than overall economic growth.

TD economist and report author Diana Petramala attributes this to the rapid wealth accumulation that occurred in this period, as home prices appreciated significantly and stock prices surged.

“The wealth accumulation meant that households felt more financially sound and it likely had a significant impact in the willingness to save less out of personal income,” Petramala says.

As the economic downturn set in last year, Canadians constrained their spending, sending the savings rate up to a six-year high of 4.7% at the end of 2008. While it could be argued that the savings rate will once again retreat as the economy recovers, Petramala does not expect the rate to fall back to its mid-decade lows.

“The increase in personal savings is likely to prove sustained,” she says.

She believes a recovery of real estate prices, stock prices and labour markets will be a long and drawn out process, which will keep consumer confidence depressed going forward. This is one factor that will prompt households to focus on rebuilding their personal balance sheets and to maintain a more generous cushion of savings.

“Even as labour markets begin to recover in 2010, consumers will likely remain jittery, as the unemployment rate is a lagging indicator and will only slowly retreat,” says Petramala.

She adds that the financial crisis has reminded Canadians of the risks of saving too little and borrowing too much. Having watched their portfolios plummet in value in recent months, Canadians will be less inclined to rely on capital gains in the future, Petramala says.

“It is expected that households will save more and borrow less during the next economic upturn, to offset some of the wealth shortfalls that occurred and to be better prepared for any future economic downturns.”

Another factor likely to drive down borrowing levels is a reduced supply of available credit, Petramala notes. In the aftermath of the credit crunch, she does not expect the rate of growth in the supply of available credit to return to its pace prior to the crisis.

“This will be a healthy trend for both households and for the financial system,” Petramala says. “The main implication is that households are likely to elect to save more for larger purchases, relative to the savings made in the last decade.”

IE