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A person shops for produce at the Granville Island Market in Vancouver, on July 20.DARRYL DYCK/The Canadian Press

It’s unclear how quickly the Bank of Canada’s sharp interest-rate increases will have their desired effect of cooling inflation. But they appear to have dampened the mood of consumers and businesses in a hurry.

The Conference Board of Canada reported this week that its quarterly Index of Business Confidence dipped to its lowest reading since the third quarter of 2020. That report came just days after the Conference Board’s released its July Consumer Confidence index, showing that sentiment has slumped to depths last seen in the COVID-19 recession.

In fact, the think tank’s consumer confidence readings have been in free fall since spring – or about the time the Bank of Canada launched into a series of historically steep rate hikes. It’s probably not a coincidence.

The falling indicators are both a predictable and, really, an entirely intended consequence of the Bank of Canada’s aggressive rate path. The central bank wants to shock consumers and businesses into a change of behaviour: Specifically, it wants to cool their demand for goods, services and labour, which had grown well beyond the economy’s challenged supply capacity.

To get there, a shift in thinking – in consumer and business sentiment – is a pretty logical first step. This is why confidence indexes are generally considered pretty good leading indicators, which provide early signals of the direction the economy is turning.

Another Conference Board report this week points to the next shoe to drop. Its Index of Consumer, a weekly gauge, went into a serious skid in June. It suggests that the decaying sentiment may already be translating into slowing consumption.

But the speed and severity in the decay of consumer and business confidence should give monetary policy makers pause. Rapid rate increases were meant to be a harsh slap of reality, but it seems we’ve been collectively slapped into recession-level anxiety. And with inflation – the ultimate target of the rate hikes – still unshaken from four-decade highs.

It’s reasonable to ask whether the bank’s unprecedented aggression has knocked too much of the wind out of consumers and businesses, too quickly. Whether it hasn’t set in motion an about-face in the economy’s “animal spirits,” as John Maynard Keynes famously called them, that has set us on a path to recession.

This is a question, at this point, a worry. It’s not a probability – yet. But the Conference Board’s sentiment readings definitely suggest a sea change in thinking among consumers and business owners.

As the Bank of Canada’s top officials approach the next rate decision on Sept. 7, they need to understand what is driving this sentiment slump. Rising rates may have been the trigger, but are they the chief concern?

That’s where the details of Conference Board’s confidence surveys get interesting.

On the one hand, high inflation still appears to be the critical driver of eroding confidence. It’s notable that business sentiment actually began drifting downward a year ago, with steadily rising cost pressures being an ongoing theme. And rising consumer inflation expectations since the spring have gone hand-in-hand with the plunge in confidence.

At the same time, the July survey indicated that while consumers have grown more worried about near-term inflation, they are confident that inflation will be tamed in the longer run.

Perhaps, then, the Bank of Canada might view its decision to accelerate rate increases as a moment of awakening for consumers to the severity of the inflation threat. At the same time, it might interpret the data as evidence that its key message – that it will succeed in quelling inflation – is resonating.

On the other hand, fast-rising borrowing costs are contributing to rising pessimism about household finances. And nearly half of surveyed businesses said that higher rates will slow their planned investment spending. There’s little question that those substantially higher rates will take a bite out of demand, and out of sentiment, as their influence spreads more widely through the economy in the coming months.

Perhaps the strong undertone of inflation fears that remain in the Conference Board data suggests that the Bank of Canada can still put a floor under consumer and business sentiment – if it can show that its inflation fight is succeeding.

This is just the sort of thing Bank of Canada Governor Tiff Macklem has been talking about in the past few months, when he has said that the bank will need to carefully parse the economic indicators to understand the effects of the rate hikes. Assessing the data will be critical to charting the path for rate policy from here.

But the bank is in a race against time. It will need a win soon in the inflation data, if it’s going to sustain the faith in its policy even as rates dig their teeth deeper into households and businesses.

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