Businesses and consumers are expecting inflation to slow faster than they previously thought but as high interest rates weigh on the economy, they’re also adjusting their finances to account for a slowdown.
That’s according to the Bank of Canada’s first quarter business outlook and consumer expectations surveys released Monday.
The surveys — which ask respondents what they think the annual inflation rate will be one, two and five years from now — show expectations for future inflation are falling. This comes as the actual inflation rate has been slowing for months, reaching 5.2% in February after peaking at 8.1% last June.
However, businesses and consumers continue to expect inflation to remain above 2% until at least 2025.
The Bank of Canada closely monitors inflation expectations in the economy because inflation can stay high if businesses and consumers continue to expect prices to rise rapidly.
The central bank is likely encouraged to see inflation expectations falling, but the surveys show business and consumers still expect inflation to be higher than the Bank of Canada’s forecasts.
It’s currently projecting inflation to fall to about 3% by mid-year and back down to 2% in 2024.
The central bank aggressively raised interest rates starting in March 2022 to clamp down on rapidly rising prices. It’s currently holding its key interest rate steady at 4.5% and doesn’t anticipate raising it again, so long as inflation cools fast enough.
The Bank of Canada will make its next interest rate decision on April 12. In a client note sent out Monday, TD director of economics James Orlando said the survey responses should encourage the Bank of Canada to stay on the sidelines.
With its key interest rate at the highest level since 2007, higher borrowing costs are expected to further constrain consumers and weigh on business activity in the coming months.
According to the survey, more consumers are reporting that they’re worse off as a result of higher interest rates and inflation than in the last survey, conducted in the fourth quarter of 2022.
Overall, 56.5% of consumers say high inflation has made them “much worse off” or “somewhat worse off.” Meanwhile, 31.3% say they’re worse off because of high interest rates.
The central bank’s surveys reveal consumers with variable-rate mortgages, Indigenous people, people with disabilities and racialized people are more likely to report being hurt by high inflation and interest rates.
With a potential recession looming, the surveys show consumers expect to pull back on spending and businesses anticipate sales will slow.
The Bank of Canada found almost half of firms have adjusted their business plans to account for a recession. And consumers are planning to spend less on activities such as travel and going to restaurants over the next year.
Orlando said the change in behaviour is a sign that the economy is in fact headed toward a slowdown.
“If consumers and businesses adjust their behaviour in preparation of a slowdown, it becomes a self-fulfilling prophecy. This implies that the string of positive surprises won’t last much longer,” Orlando said.
So far, the economy has been relatively resilient amid high interest rates. Statistics Canada reported earlier this week that real gross domestic product rose by 0.5% in January after declining by 0.1% in December. Its preliminary estimate for February suggests another increase of 0.3%.
The labour market in particular has shown strength, with the economy continuing to add jobs even as recession talk bubbles.
And while labour shortages are still the second most important issue facing firms, the surveys show signs of easing in the labour market, with businesses no longer anticipating rising wages to push inflation higher.
The Bank of Canada has raised concerns over the tight labour market and rising wages fuelling inflation. Canada’s unemployment rate was hovering near record lows in February, sitting at 5%. Meanwhile, wages were up 5.4% from a year ago.