Key Takeaways:
Canadian business inflation expectations surged in the second quarter, though the spike largely reflects energy-cost fears that have since receded after the U.S.-Iran ceasefire drove crude prices sharply lower.
The Bank of Canada's quarterly business-outlook survey, published Monday, showed 44% of firms now expect inflation to run above 3% over the next two years, quadruple the 11% recorded in the first quarter. The jump was concentrated in expectations for nonlabor input costs and selling prices, which rose to levels last seen in early 2023, according to the central bank.
"The surveys warrant more careful interpretation than usual, with an emphasis on identifying signals that remain relevant under today's conditions," said Tiago Figueiredo, an economist at Desjardins Securities. The bulk of responses were collected via phone and video interviews from May 1 to May 21, before the U.S. and Iran reached a deal allowing oil-tanker traffic to resume through the Strait of Hormuz.
The average price of a barrel of crude oil stood at about $90 during the survey period. By Monday, benchmark prices had fallen to the high-$60 range after the June 14 interim agreement between Washington and Tehran. A separate follow-up survey of business leaders conducted by the Bank of Canada showed inflation expectations declined in the period after the ceasefire, the central bank said.
The data presents a complex picture for policymakers ahead of the Bank of Canada's next rate decision on July 15. Governor Tiff Macklem said in late June that the Middle East truce removes some upside risk to inflation, and money markets and economists expect the central bank to hold its benchmark rate at 2.25% through at least the end of 2026. Canada's annual inflation rate accelerated to 3.2% in May, a two-year high, though Macklem said there was limited evidence of higher energy costs spilling over into other goods and services.
Business sentiment softens as trade fears ease
The bank's business outlook indicator, a composite measure of prospects under current economic conditions, fell to -0.39 in the second quarter from -0.35 in the first quarter, the first decline in three quarters. The reading remained well above the -2.41 recorded a year earlier, when trade tensions with the U.S. were at their peak.
The share of firms planning or budgeting for a recession in Canada over the next 12 months rose to 17% from 9%, the survey showed. Sales outlooks softened slightly, reflecting a slowdown in business and consumer spending tied to rising fuel-related costs. Employment intentions weakened, and firms continued to report spare capacity.
Trade-related uncertainty, while still present, has eased from the worst-case scenarios that dominated last year. Fewer firms reported that U.S. customers were holding back on orders because of changing trade policies, the survey noted. Investment intentions were largely unchanged from the prior quarter and remained at an elevated level, driven primarily by domestic demand and routine maintenance.
Policy implications and the path forward
The Bank of Canada is introducing two new indicators related to business activity and price behavior starting this quarter, part of an effort to better understand the nature of the economic shock. The activity indicator declined, largely reflecting a weaker sales outlook, while the price indicator increased due to expectations for both higher inflation and stronger growth in input and selling prices.
The last time the Bank of Canada faced a similar divergence between near-term inflation fears and a softening growth backdrop was in early 2023, when the central bank held rates steady for several months before ultimately resuming hikes as core inflation proved sticky. Minutes from the bank's most recent deliberations showed policymakers did not want to overreact to the jump in energy prices but also did not want to be slow to react to any spillover that might accelerate a pickup in inflation.
For now, the collapse in crude prices from the May survey period suggests the inflation expectations data may already be stale. "Some of the concerns over growth in this report, and especially on inflation, should be behind us," said Robert Kavcic, an economist at BMO Capital Markets. Canada's economy rebounded in April and is on track for annualized growth of more than 2% in the second quarter, offering some relief after two straight quarters of contraction.
This article is for informational purposes only and does not constitute investment advice.
