The polling of 600 businesses – conducted in late August and early September – found that 70 per cent of companies expect that inflation will prompt them to cut costs over the next year.Nathan Denette/The Canadian Press
If you’ve ever wondered how high inflation can smother economic growth and prosperity, just ask businesses how they plan to spend their money in the next year.
Modus Research did just that in a soon-to-be-released survey of Canadian business. (Modus gave The Globe and Mail an advance glimpse at the data.) It shows that rising costs from inflation are about to take a deep bite out of private-sector spending in key areas that promote future economic expansion.
The polling of 600 businesses – conducted in late August and early September – found that 70 per cent of companies expect that inflation will prompt them to cut costs over the next year. Nearly half said they intend to reduce investment on new equipment; 35 per cent said they plan to cut research and development. One-third said they would cut back on hiring.
That’s problematic.
It suggests that high inflation is becoming embedded into companies’ future plans. The Bank of Canada, which has been aggressively raising interest rates to try to quell inflation, has repeatedly warned that once higher inflation expectations become entrenched in business and consumer expectations, it becomes much more difficult to bring down to size. (The current inflation rate of 7 per cent is a full five percentage points above the central bank’s long-standing sweet spot of 2 per cent.)
The Modus numbers provide some hints of what we might see in the Bank of Canada’s own quarterly business outlook survey, which comes out Oct. 17 – just nine days before the central bank’s next interest rate decision. The bank has been watching closely and nervously for signs that the private sector’s inflation expectations are drifting higher.
In the bank’s last survey, published in July, inflation expectations moved notably higher over the next year or two, but long-term expectations remained anchored fairly close to the bank’s 2-per-cent target. At the same time, most businesses indicated that they continue to expect to increase investments in machinery and equipment in the next year, in response to strong demand.
But we’re now three months further down a global economic road that has been made increasingly rocky by persistent high inflation, and central banks’ aggressive interest rate hikes in response. The Bank of Canada will be keenly interested in how well businesses’ spending intentions are holding up under the pressure, and how their inflation expectations are colouring those plans. The Modus findings are hardly encouraging.
Why is it such a problem for the economy when businesses start assuming high inflation, and planning for it? It’s about a lot more than just businesses building higher wage increases into their budgets and passing those higher expenses on to customers. (Though that’s certainly an important, and inflationary, element.)
Business investment – on machinery and equipment, on R&D – is a key part of the solution to the current inflation problem. We have too much demand relative to the economy’s capacity to supply goods and services. And much of this has been supply driven: The COVID-19 pandemic and its aftershocks have severely disrupted global supply chains, leaving them lagging far behind the recovery in demand.
We need businesses to respond by expanding their capacity and improving their productivity, to raise the bar on the supply side of the equation. This would, indeed, be a much more constructive outcome than a slump in demand (i.e., a recession).
But if inflation (and expected inflation) eats the budgets to invest in the things that achieve that, capacity and productivity growth can stall – and, with it, the economy’s ability to grow.
This is the kind of lasting damage that a vicious cycle of inflation can inflict. It’s this type of longer-term pain that the Bank of Canada is trying to avoid by quelling inflation now, and keeping expectations from running loose and taking over business and consumer psychology.
What businesses say they expect to do over the next year, and what they actually do, can be two different things – and they very much depend on how the economy evolves over that time. Think of it as similar to Scrooge’s visit from the Ghost of Christmas Yet to Come. These are things that may be, if inflation conditions don’t improve; they aren’t preordained, it’s not too late to change.
Indeed, the progress on inflation even since the Modus survey was taken could begin to contain fears that high inflation will be a lasting phenomenon, and cool business worries that spending must be slashed to deal with soaring costs. The inflation rate in August – released after the survey was completed – dropped to 7 per cent from July’s 7.6 per cent. The math for corporate budgeters is already a bit better than it was when Modus asked those questions.
These sorts of survey findings will serve to underline for Bank of Canada policy makers that they need to keep their foot on the gas, to rein in inflation before the pessimism becomes entrenched in Corporate Canada’s planning. If you need an explanation for why the central bank has been so determined to raise interest rates so much, so quickly, this is as compelling as any.