The Bank of Canada’s Business Outlook Survey leaves us with two key takeaways: inflation pressures will continue to ease, but the economic outlook looks more pessimistic.
All of the key inflation metrics tracked by the Bank—headline inflation expectations, input and output price expectations, price setting behaviour, wage pressures, and supply chain disruptions—point toward diminished price growth. That said, disinflation won’t be a quick job, as the survey suggests that many of the key drivers of inflation will remain above target for some time. On the output side of things, business sentiment, investment plans, and sales growth expectations dropped off sharply, and the majority of firms expect the economy to enter a recession in 2023. This should help the Bank with its goal of reducing excess demand, but it also increases the risk of a future policy pivot.
Firms’ inflation expectations are easing at all time horizons, having peaked in the summer between June and August, depending on the horizon.
The inflation expectations data combine responses from the BOS as well as the Bank of Canada’s newest survey, the Business Leaders’ Pulse (BLP) survey, which is timelier and more frequent but less detailed than the BOS. The latest estimates from October showed that 1-year expectations fell to 4.7%, 2-year expectations fell to 2.9%, and 5-year expectations fell to 2.4%. Back in August, those same measures were at 5.6%, 3.4%, and 2.6% respectively.
Businesses also said that they expect growth in both input and output prices to slow.
The net balance of opinion was negative for both types of prices for the first time since 2020Q2, and the most negative since the 2008-09 recession.
Currently, firms report that the key source of pressure on output price growth is coming from rising labour costs, with pressures from commodity prices, services, and other non-labour costs having all dramatically receded from the second quarter. Wage growth over the next 12 months is now expected at 4.9%, having peaked at 5.8% last quarter.
Firms’ input and output price growth expectations drop off sharply in Q3
The Bank noted that firms’ price-setting behaviour shifted considerably in the immediate aftermath of the pandemic as elevated demand, supply constraints, and diminished competition allowed firms to pass on larger and more frequent price increases to their consumers than pre-pandemic.
Currently, however, most businesses have either returned or plan to return to their pre-pandemic behaviour, which entails infrequent price adjustments and higher attention paid to competitors’ prices.
Finally, the share of firms facing labour bottlenecks edged down 1 percentage point to 62%, while the share with supply chain bottlenecks held flat at 43%. Both of these metrics are still just off the highs and substantially higher than pre-pandemic, which are key reasons why the disinflation that’s set to come will take time.
The biggest risk to the disinflation story coming from businesses comes from the consumer.
The BOS’s sister survey, the Canadian Survey of Consumer Expectations, showed that consumer inflation expectations and perceptions of current inflation continued to increase this quarter. Nevertheless, the majority of consumers also expect a recession next year, and report changes to their spending patterns by delaying major purchases and simply spending less to cope with inflation. Inflation expectations only matter to the economy if people act upon those expectations. Delaying purchases en masse, however, is consistent with deflationary expectations and should somewhat soothe central bankers’ fears.
The weight of the evidence from today’s two surveys suggests that the Bank of Canada will become, on the margin, a bit more dovish.
Diminished inflation pressures mean that less monetary tightening is needed, and despite the unanimously hawkish rhetoric from Governor Macklem, growth risks are mounting and will be a key internal debate within the Governing Council. Factoring in the financial stability risks associated with an imminent recession and tighter monetary policy stance, along with the fact that the opposite trend in inflation is underway in the US, the gap in US and Canadian interest rates should widen further and result in further upside for USDCAD.
Jay Zhao-Murray, FX Markets Analyst