Canadian employees can expect pay raises of 3.5% next year, according to findings from the 2006 Annual Canadian Salary Survey, released by Watson Wyatt Worldwide on Thursday.

“The continuous growth of the Canadian economy, combined with historically low unemployment rates, are forcing employers to take a closer look at their compensation practices to ensure they’re able to attract and retain top talent in an increasingly competitive environment,” says Graham Dodd, Western Canada managing consultant, with Watson Wyatt Canada. “Given these conditions, we expect that actual salary increases will likely exceed respondents’ forecasts.”

As employers face mounting pressure to provide competitive monetary compensation, they are also turning to complementary strategies to better engage employees and tie pay to performance.

In 2006, 89% of respondents confirmed they have short-term incentive plans in place, slightly higher than the 88% in 2005 and 86% in 2004. Additionally, 85% indicated that merit increases (based on performance) are a factor when determining their annual salary-increase budget.

But while Canadian employers are indeed tying pay to performance, the difference in merit increases between average-performing employees and top performers remains limited – at 3.1% and 5.6%, respectively (compared to 2.9% and 5.4% in 2005).

“The move to differentiate compensation of low- vs high-performing employees is starting to take hold in Canada, as employers become more strategic about tying pay to performance,” said Dodd. “However, the survey findings reveal there is room for further improvement as the current difference in merit-pay increases is not particularly significant.”

Survey participants also face key human resource issues. “The looming talent crunch and departure of baby boomers from the workforce have brought ‘key-talent recruitment’ and ‘succession planning’ to the top of employers’ agendas in the short- and mid-terms, respectively,” adds Liz Wright, Toronto practice leader, compensation with Watson Wyatt.

“Additionally and perhaps most notably, is the emergence of ‘employee engagement’ to the top five issues list. Canadian employers are starting to realize the importance of complementing HR strategies beyond compensation to attract and retain talent. With the expected high demand for skilled labour, employers that do not fully and effectively utilize a comprehensive approach to talent retention may find themselves losing top-performers to the competition.”

The survey also provides interesting insights on the heated Canadian labour market for various industry sectors and geographic regions. For the first time in many years, the public sector is nudging ahead of the private sector with a 3.6% forecasted salary increase.

Professional/business services also continue to feel the pressure of high labour demand as evidenced by the above-average (4.4%) base salary increase this sector experienced in 2006.