Canadian Firms Optimistic About Inflation Easing Amidst Weaker Demand
Canadian firms expect inflation to ease over the next two years, according to a survey conducted by the Bank of Canada. This positive outlook comes as the business environment faces its lowest level since the pandemic began.
Concerns about Recession
The survey revealed that around one-third of firms anticipate a recession in the coming year, which remains consistent with the previous quarter. The Bank of Canada, which has raised rates 10 times since early 2022, decided to keep rates at 5% during its September 6 meeting. The central bank acknowledged that the economy was entering a period of slower growth. The next policy decision is scheduled for October 25.
Consumers’ and Businesses’ Outlook
A separate survey showed that 55% of consumers anticipate a recession in the next year, up from 50% in the previous quarter. Meanwhile, 27% of businesses believe it will take more than three years to bring inflation down to the central bank’s target of 2%, a decrease from 32% in the previous quarter.
“Reports of softer demand are broad-based,” stated the survey. “Signs indicate that pricing behavior is moving toward normal. A continued softening in demand conditions is creating an environment where firms are less able to pass through input cost increases.”
The business outlook survey index, which provides a comprehensive assessment of firms’ prospects, dropped to -3.51, the lowest level since the second quarter of 2020 (-6.16).
“The Bank of Canada’s aggressive rate hikes are working as intended, with both businesses and consumers expecting a slowdown in activity,” noted BMO Capital Markets economist Shelly Kaushik.
Approximately 53% of businesses anticipate inflation to remain above 3% in the next two years, compared to 64% in the previous quarter. Bank of Canada Governor Tiff Macklem recently stated that officials would consider whether to let previous rate hikes impact the economy or raise rates further to counter persistent inflation.
Current Economic Situation
The economy unexpectedly contracted in the second quarter and stalled during the first two months of the third quarter. Additionally, core inflation has proven to be stubborn.
The Canadian dollar experienced a 0.2% increase, trading at 1.3625 against the US dollar, or 73.39 US cents. Money markets indicate a 40% chance of a rate hike on October 25.
Although interest rates are at a 22-year high, the central bank does not anticipate inflation slowing to 2% until mid-2025.
Consumer Inflation Expectations
Consumers’ inflation expectations for the next year slightly eased, but they still anticipate inflation to be above 5%. However, Canadians perceive inflation to be much higher than it actually is, estimating it to be 6.6% instead of the recorded 4.0% in August.
“For the Bank of Canada, consumers’ sticky inflation expectations are problematic,” said Royce Mendes, head of macro strategy at Desjardins Group. “Given that both businesses and households expect the economic environment to weaken, we don’t think there’s enough evidence to suggest that the economy requires higher interest rates.”
Wage Pressures and Labor Shortages
Wage pressures, closely monitored by the central bank, are easing, although businesses still anticipate higher-than-normal wage increases in the next year. The survey also highlighted a widespread relaxation in labor shortages.