What do you think the current inflation rate is? And what will it be in a year?
Imagine my surprise when I read the responses from consumers surveyed by the Bank of Canada. According to the average Canadian, the current inflation rate is 5.2%, almost twice the rate measured by Statistics Canada (2.7%).
And while the vast majority of economists expect the inflation rate to hit the 2% target soon, consumers predict it will be 4.1% a year from now. Isn’t that surprising?
Consumer Expectations Survey1published Tuesday by the Bank of Canada, shows how far consumers’ perception is from reality. This perception could be of a nature to influence the Bank’s decisions.
This gap is not only observed for the consumer price index (CPI) – sometimes contested – but also for other elements.
According to the survey, for example, Canadians estimate that their wages have increased by 2.4% over the past 12 months. However, declarations by businesses to Revenue Canada and by workers to Statistics Canada indicate increases of 3.7% to 4.6% for the same period.
How can these discrepancies be explained? And why does the Bank care?
First, consumers probably tend to confuse the price level and its increase, estimates economist Benoit Durocher, of the Desjardins Movement.
“Consumers are hoping that prices will drop to return to 2021 levels, which will not happen. This phenomenon plays a big part in this perception,” believes Mr. Durocher.
Another possible factor: Consumers are more likely to see big increases, such as those for gasoline and housing, but are forgetting about items in the consumer basket that are rising little or falling, such as clothing and furniture.
Statistics Canada measures the evolution of the entire basket of goods and services typical of consumers, not just the most salient items. The basket is calibrated according to household spending.
Consumer perception is a significant factor for the Bank. Why? Because it can provide insights into consumer behavior, which could influence inflation and, ultimately, the key rate.
Indeed, if consumers expected inflation to rise by 50% within a year—to take an extreme example—they would tend to bring forward their purchases to take advantage of current low prices, and this bringing forward, in itself, would raise inflation.
“If consumers and businesses expect the inflation rate to remain high for longer, they will demand to be compensated for their wages or their prices,” Matthieu Arseneau, an economist at the National Bank, told me.
For keen observers, the most important thing is the evolution of this consumer perception. In the fall of 2022, consumers estimated inflation at 8% (rather than the actual rate of 7.2%), and today, this perceived rate has fallen to 5.2%, much lower. The decline is similar for expected inflation a year later.
Mathieu Arseneau places more importance on the perception of businesses, surveyed in another survey published the same day (July 15) by the Bank of Canada.2. However, these perceptions argue in favour of deflating inflation.
Not only have business hiring and investment prospects declined, but wage growth expectations are lower.
As for the labour shortage, it is almost a thing of the past: only 15% of Canadian businesses say they are still suffering from it, compared to more than 40% two years ago.
These factors are likely to slow economic activity and inflation and therefore prompt the Bank of Canada to reduce its key rate. The National Bank’s team of economists also predicts that the key interest rate will fall by another 75 basis points by the end of 2024, to 4%.
The recently announced drop in the inflation rate (2.7% in June) also argues for an easing of the key rate, since this inflation rate is in the 1% to 3% range cherished by the Bank of Canada. The next announcement on the key rate is on Wednesday, July 24.
Recession fears are fading
In any case, the perception of consumers and businesses is interesting in another respect: both groups judge that the risk of recession is diminishing, which is a good sign.
Among businesses, 20% expect there to be a recession in a year, whether severe (3%) or mild (17%). This proportion was 37% six months ago.
On the consumer side, 51% believe that the Canadian economy will experience a decline within 12 months, whether significant (20%) or slight (31%). This proportion was 61% six months ago.
On the other hand, consumers surveyed now believe that the probability of losing their job within a year is greater (14.6%) than six months ago (10.9%).
In short, without being rosy, the coming months will probably see inflation fall back to the 2% target and interest rates reach a more reasonable level. This will be to the great satisfaction of owners who have a large mortgage or buyers looking for a home.
1. Consult the Canadian Consumer Expectations Survey
2. Consult the Business Outlook Survey