–Firms’ Inflation Expectations Edge Down but Remain High
–Consumers’ 2-Year Inflation Outlook Rises Slightly to 4%, Still See 5% Price Rise in Year Ahead
–Businesses, Households Believe Effects of High Interest Rates Far from Over
By Max Sato
The survey also showed firms’ inflation expectations edged down but remain higher than they were before the pandemic. “Most firms think inflation will return to 2% in the long term, but uncertainty about when this will happen has increased,” the bank warned. “Roughly one-third of firms still believe it could take longer than three years before inflation returns to the bank’s 2% target.”
When it comes to bringing inflation back to the inflation-control target range of 1% to 3%, “an increasing share of businesses are confident” that the bank should be able to do so “within in the next one to two years.”
The business outlook indicator fell to a more than three-year low of minus 3.51 in the third quarter from minus 2.31 in the second quarter, minus 0.97 in the first three months of 2023 and plus 0.20 in the final quarter of 2022. Excluding the pandemic period, it was the worst since minus 3.62 in the third quarter of 2009.
“The summary measure of core questions in the BOS is now at its lowest level in over a decade, except for a brief period early in the Covid‑19 pandemic,” the bank said.
The BOS indicator has declined from its record high of 5.68 hit in the fourth quarter of 2021. The indicator plunged to minus 6.14 in April-June 2020 from minus 0.63 in the previous quarter during the first wave of the pandemic. The entire time series of the indicator is revised after every release.
Slowdown in Demand Is Widespread
“Businesses reported that demand has slowed, contributing to weak sales growth over the past year,” the survey found. “The share of firms citing outright declines in their sales also increased notably — one-third of respondents said their sales have fallen over the past year. The slowdown in demand is widespread across regions and sectors.”
The latest business survey showed that fewer firms than in previous surveys mentioned cost pressures, labour shortages or disrupted supply chains. “Despite this, cost pressures remain the top issue for firms,” the bank said “Concerns around slowing demand and tighter credit conditions, meanwhile, continue to rise.”
Firms expect growth in demand to continue to be subdued but at the same time, the share of those planning for a recession in the coming year — about one-third — has not risen, the bank noted.
Pricing Behavior ‘Abnormal’
About half of businesses reported their pricing behavior is “abnormal,” the bank said, adding, “Looking forward, on balance, firms continue to plan larger and more frequent price increases than usual over the next 12 months.”
Some firms are still passing the spike in costs caused by the pandemic onto consumers due to supply chain issues, strong demand and unusually large wage hikes, the bank said.
“More than half of firms surveyed believe that the effects of past monetary policy tightening on their business are far from over,” the bank said. “Firms are impacted primarily through the higher cost of debt that they and their customers face.”
Easing Labor Market
Good news for the bank is that firms reported “a widespread easing in the intensity of labour shortages compared with the very tight labour market at this time last year.”
Intentions to hire are below their historical average, the bank said. “A larger share of firms than in previous surveys said they have adequate staffing levels given their sales outlook, and fewer businesses need to fill vacancies.”
Inflation Expectations Lower but Still High
In the latest survey, firms’ inflation expectations over the next two years continued to moderate to 3.29% in the September quarter from 3.53% in the June quarter and 3.89% in March.
The share of firms expecting inflation to be above 3% over the next year fell further to 53% in the latest survey from 64% previously and 79% in the first quarter while that of firms foreseeing inflation to be between 2% and 3% rose further to 39% from 30% in the second quarter and 17% in first quarter.
Ahead of their next policy rate announcement on Oct. 25, the bank’s policymakers will monitor more data including the release on Tuesday of September CPI data, and discuss whether further tightening is needed to guide inflation to back to target after the recent uptick in the CPI annual rate to 4% in August.
The survey was conducted from Aug. 14 to Sept. 8. Toward the end of this period, the bank on Sept. 6 announced it decided to maintain its policy interest rate — the target for overnight lending rates — at a 22-year high of 5.0% after two consecutive rate hikes, in the wake of weak second quarter GDP data, but the bank’s policymakers also kept their hawkish tone, leaving the outlook uncertain as to whether the bank is done with credit tightening launched 18 months ago.
Consumers’ Inflation Outlook Remains Elevated
In its quarterly survey of consumer expectations for July-September, the Bank of Canada said consumers’ perceptions of current inflation “remain elevated” and are leading to persistently high expectations for inflation over the next 12 months.
“The gap between perceptions of inflation and actual inflation is unusually wide,” the bank said. “This is likely because many consumers form their views based on their own shopping experience. Households with a large gap expect high price growth for essentials like food and housing.”
Consumers’ expectations for inflation are also tied to economic factors, such as government spending and tax policies, labour shortages and businesses increasing profits.
Consumers’ expectations for interest rates one year from now also remain high, the survey showed. “Many people think increases in interest rates are raising the cost of living and keeping inflation high,” the bank said.
As shown in the bank’s business survey, “Many consumers believe the impacts of higher interest rates on their household spending are far from done.”
Consumers’ inflation expectations over the next two years edged up to 4.04% in the September quarter amid the recent uptick in energy prices, after falling to
3.93% in the June quarter from 4.27% in the March quarter. Their outlook for the coming year is 5.03% down from 5.09% in June and 6.03 in March.
Some of the findings are challenging for the central bank.
“Consumers are also skeptical about whether raising interest rates can lower inflation,” the bank said. “While most consumers understand that higher interest rates are intended to reduce inflation, less than half of consumers believe they will.”
The consumer survey was conducted between Aug. 4 and Aug. 16. Follow-up interviews took place from Sept. 5 to Sept. 11. Since the previous survey in May, there were two rate hikes by the bank, by 25 basis points each in June and July.