Businesses and consumers expect inflation to slow faster than they previously thought, but as high interest rates weigh on the economy, they are also adjusting their finances to account for a slow-down.
That’s according to two surveys on business outlook and consumer expectations for the first quarter, released Monday by the Bank of Canada.
Surveys — which include asking respondents to predict annual inflation one, two and five years ahead — show that expectations for future inflation are falling. This comes as annual inflation has been slowing for months, having reached 5.2% in February, after peaking at 8.1% last June.
However, consumers and businesses continue to expect inflation to stay above 2.0% at least until 2025.
The Bank of Canada is closely monitoring inflation expectations in the economy, fearing that inflation could become more persistent if businesses and consumers continue to expect rapid price increases.
The central bank is likely encouraged to see inflation expectations lower, but polls show that businesses and consumers still expect inflation to be above the Bank of Canada’s forecast.
It currently expects inflation to decline to around 3.0% by mid-year, and to 2.0% in 2024.
Deterioration of the financial situation of households
The central bank has been aggressively raising interest rates since March 2022 to suppress rapidly rising prices. It currently maintains its key interest rate at 4.5% and does not plan to raise it again, as long as inflation slows down fairly quickly.
The Bank of Canada will make its next interest rate decision on April 12. In a note sent to clients on Monday, TD Bank chief economics officer James Orlando said the survey responses should encourage the central bank to stay on the sidelines.
With the key rate at its highest level since 2007, rising borrowing costs are expected to further constrain consumers and weigh on business activity in the coming months.
According to the survey, more consumers calculate that their financial situation has deteriorated due to rising interest rates and inflation than in the last survey, conducted in the fourth quarter of 2022. Overall , 56.5% of consumers say their financial situation has deteriorated “a lot” or “worsened slightly” due to high inflation. Meanwhile, 31.3% say their situation has deteriorated due to high interest rates.
Central bank surveys show that consumers with adjustable rate mortgages, Indigenous people, people with disabilities and people of color are more likely to report being affected by high inflation and high interest rates.
With a potential recession looming, surveys show consumers expect to cut spending and businesses anticipate slower sales.
The Bank of Canada found that nearly half of companies had adjusted their business plans to account for a recession. And consumers expect to spend less on activities like travel and dining out over the next year.
Self-fulfilling prophecy
Orlando said the changes in behavior were a sign that the economy is actually heading for a slowdown. “If consumers and businesses adjust their behavior in anticipation of a downturn, it becomes a self-fulfilling prophecy. This implies that the series of positive surprises will not last much longer. »
So far, the economy has been relatively resilient in the high interest rate environment. Statistics Canada reported last week that real gross domestic product rose 0.5% in January, after declining 0.1% in December. Its preliminary estimate for February suggests another increase, of 0.3%.
The labor market, in particular, has shown strength, with the economy continuing to create jobs even as the rhetoric of the recession is heard. And while labor shortages remain the second biggest problem facing businesses, surveys show signs of easing in the labor market as businesses no longer expect rising wages drive up inflation.
The Bank of Canada has expressed concern that a tight labor market and rising wages are fueling inflation. Canada’s unemployment rate neared record lows in February, at 5.0%. Meanwhile, wages rose 5.4% from a year ago.