Canadian businesses and consumers are increasingly feeling the pinch of higher interest rates meant to tamp down rising prices, however both groups still believe that inflation will remain elevated for an extended period of time, according to a pair of surveys by the Bank of Canada.
The central bank’s quarterly business survey found that companies expect their sales to be subdued over the coming year, and many anticipate pulling back on hiring and investment. A separate quarterly survey of consumers found that households are reducing spending in response to higher borrowing costs, particularly on big-ticket items, and that expectations of a recession are growing.
At the same time, both businesses and consumers expect inflation to remain high in the coming years. And corporate pricing behaviour continues to be abnormal, with companies planning larger and more frequent price increases than before the COVID-19 pandemic, even as cost pressures lessen and the overall business environment weakens.
This may concern the Bank of Canada as it prepares for its next interest-rate decision on Oct. 25. The bank has said it’s watching inflation expectations and price-setting behaviour particularly closely for signs of inflationary pressure. The bank held its benchmark interest rate steady at 5 per cent last month, but has said it could raise rates again if inflation and other economic indicators aren’t moving in the direction it wants to see.
“The Bank of Canada’s aggressive rate hikes are working as intended, with both businesses and consumers expecting a slowdown in activity,” Bank of Montreal economist Shelly Kaushik wrote in a note to clients.
“However, policymakers will take note that inflation and wage expectations remain well above target, and are only receding slowly. The broadly downbeat tone of these surveys support our call for the bank to remain on hold, with a tightening bias, at next week’s meeting.”
The business survey was conducted in August and early September. The consumer survey was conducted in August with follow-up interviews in early September.
The Business Outlook Survey indicator, which captures business sentiment in one number, fell to the lowest level in over a decade, outside of the depths of the pandemic. Indicators of futures sales, including orders and sales inquiries, are declining and many companies are dialing back plans for hiring and investment.
“An increasing share of firms across a broad range of sectors reported that higher interest rates are negatively affecting them,” the Bank of Canada said. And more than half of the businesses surveyed believed the impacts of earlier rate hikes were “far from over.”
On the other hand, companies expect labour cost pressures to decline as the job market cools. Companies said they are finding it easier to hire the workers they need, and many expect wage growth to slow over the coming year.
Consumers have a different view of the labour market and their prospects for wage increases. In the consumer survey, people reported a higher-than-normal likelihood of quitting their jobs for new work, which suggests confidence in the job market, and expectations for future wages ticked higher.
“The tug-of-war between employers and workers appears to have intensified in the third quarter,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients. “The contrasting views have played out very publicly in labour negotiations.”
This is reflected in differing views about future inflation. Business expectations for inflation have been falling for the past year-and-a-half, even as they remain elevated. The mean forecast for inflation two years out is now 3.29 per cent, down from 4.78 per cent in the summer of 2022. The Bank of Canada targets 2-per-cent annual Consumer Price Index inflation. It was running at 4 per cent in August.
Consumers, by contrast, expect considerably higher inflation in the near-term, and the Bank of Canada noted that “the gap between perceptions of inflation and actual inflation is unusually wide.”
“This is likely because many consumers form their views based on their own shopping experience,” the bank said, pointing to the rapid rise in food and housing costs.
The combination of high inflation expectations and rising interest rates is eroding consumer confidence, particularly for homeowners, who are facing a major hit to affordability.
“Most homeowners’ mortgage payments are near or beyond the maximum level that they can manage without making significant spending cuts,” the bank said, although it added that most mortgage holders “still believe they can meet higher payments at renewal and think the likelihood they will default on their debt is low.”
Statistics Canada will release the September inflation numbers on Tuesday. This will be the last key piece of data before the Bank of Canada’s rate decision next week. Financial markets are currently pricing in a roughly 40-per-cent chance of a quarter-point rate increase on Oct. 25.
Mark Rendell