Business and consumer sentiment sours, while inflationary pressures ease, BoC surveys find

Canadian business and consumer sentiment continues to sour in the face of rising interest rates, while expectations of future inflation have begun to level off. These factors could influence the Bank of Canada as it considers slowing, or perhaps pausing, interest rate hikes in the coming weeks.

A pair of surveys released by the central bank on Monday show consumers are cutting back on spending and many companies expect a slowdown in sales. The majority of respondents to both surveys believe the Canadian economy will enter a recession in the coming year, although most expect it will be a mild to moderate slowdown.

The Business Outlook Survey, conducted from mid-November to early December, also showed that companies are experiencing less intense labour and supply chain constraints. That suggests inflationary pressures are easing.

While the pair of surveys paint a downbeat picture of the Canadian economy at the end of 2022, they suggest the Bank of Canada’s interest rate hikes are having their intended effect. The bank raised borrowing costs seven times last year, intentionally squeezing households and companies in an effort to bring runaway inflation back under control.

The surveys will be a key input in the central bank’s Jan. 25 interest rate decision. After its latest rate hike in December, the central bank said that it was becoming more “data dependent,” hinting that it’s near the end of its historic rate-hike cycle and open to a potential pause as early as this month.

Most Bay Street analysts expect at least one more 25-basis-point rate hike on Jan. 25, given the stronger-than-expected inflation report for November and a blockbuster December jobs report. That would bring the Bank of Canada’s policy rate to 4.5 per cent.

“This report will be welcome news given ongoing concerns surrounding the persistence of price pressures and an environment of material excess demand,” Andrew Kelvin, Toronto-Dominion Bank’s chief Canada strategist, wrote in a note to clients.

“As much as recent reading on employment and prices argue for additional tightening, the survey data very much suggests that the Bank may be quite close to the end of its tightening cycle.”

The Business Outlook Survey Indicator, which pulls together various survey responses into a single data point, dropped to near zero, the lowest level since the third quarter of 2020. More businesses than usual said they expect their sales to slow in the coming year, while many dialled back plans to hire new workers and invest in new machinery and equipment.

On a more positive note, business capacity pressures appear to be easing.

“Although still above pre-pandemic levels, the number of businesses reporting labour and supply chain bottlenecks as obstacles to meeting an unanticipated increase in demand has declined. This suggests that the gap between demand and supply is narrowing,” the central bank said in the survey report.

Companies still expect inflation to remain well above the bank’s target of 2 per cent annual Consumer Price Index inflation for several years. But the average estimate for inflation two years from now continued to decline, falling to 4.18 per cent from a high of 4.78 per cent in the survey last June.

Canadian consumers also expect inflation to remain high for the foreseeable future, according to the Survey of Consumer Expectations, conducted from late October to mid-November. That said, expectations about inflation one year and two years out have levelled off, after rising quickly since mid-2021. And expectations for inflation in five years’ time have fallen noticeably in the past two quarters.

Inflation expectations are a key variable for the Bank of Canada. What workers and businesses believe about future inflation can impact wage negotiations and price-setting behaviour. The central bank remains concerned that the longer inflation stays high, the more likely that it will become baked into people’s psychology, making the bank’s inflation control job more difficult.

Overall consumer sentiment is gloomy. Survey respondents reported spending more on necessities and less on discretionary items, as high inflation and rising interest rates both squeeze their finances. More than half of all survey respondents did not expect their wages would keep pace with inflation.

Moreover, a growing share of consumers are postponing large purchases. This is especially the case for homeowners with variable-rate mortgages, who have seen their monthly debt-servicing costs rise rapidly, the bank said.

“The BoC’s aggressive rate hikes through 2022 have clearly weighed on economic sentiment among both businesses and consumers,” Bank of Montreal economist Shelly Kaushik said in a note to clients.

“However, still-elevated inflation expectations will keep the Bank on alert. This survey is consistent with our call of a 25 bp rate hike at next week’s meeting, after which we anticipate the Bank will hold interest rates steady through the remainder of 2023.”

The central bank will get crucial inflation data on Tuesday, when Statistics Canada publishes the Consumer Price Index report for December.

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