Inflation expectations over the next few years have hit a record in Canada, a worrying development that will prompt bets for more aggressive interest rate hikes.
The Bank of Canada’s quarterly surveys of executives and consumers released Monday showed price pressures that have pushed inflation to four-decade highs are expected to last longer than previously thought as the country faces tighter markets of labor and companies are affected by rising input costs.
The reports, which also show continued evidence that businesses are facing unprecedented challenges in meeting demand, illustrate the urgency for Governor Tiff Macklem to quickly withdraw stimulus from an overheated economy amid concerns that inflation is firming.
Markets were almost fully pricing in a 75 basis point hike in the central bank’s July 13 decision, which took the key interest rate to 2.25 percent. The bank is expected to raise it to 3.5 percent by the end of this year. The benchmark was just 0.25 percent in March.
The Canadian dollar was little changed on the report, trading 0.2% higher at $1.2879 per US dollar at 12:13 pm in Ottawa. Canadian two-year bond yields pared losses 1 basis point to 3.08 percent.
“The Bank of Canada is concerned that long-term inflation expectations could be on the wrong side,” said Nathan Janzen, assistant chief economist at Royal Bank of Canada, in a note to investors. “To prevent this outcome, moving interest rates higher than the currently low levels is easy to do.”
On a positive note, the central bank said it still has confidence the Bank of Canada can meet its 2 percent inflation target and that price pressures will eventually ease.
Consumer expectations for price increases rose across all time horizons, with households seeing inflation of 6.8% over one year and 5% over two years. Both are records.
Five-year inflation also increased significantly to 4%, but still remains slightly below pre-pandemic levels.
The business survey found that about 78 percent of businesses expect inflation to exceed 3 percent over the next two years, also a record.
Expected price gains are a key driver of actual inflation. Businesses are raising prices, and workers are seeking wage increases, in part based on their expectations of what costs will look like going forward.
In addition to rising inflation expectations, the business survey of executives paints a picture of an economy still stretched to its limits. While businesses expect sales growth to slow, demand conditions remain strong, with firms constrained by labor shortages and supply chain bottlenecks “suggesting that supply is not keeping pace with demand”.
Businesses expect “significant” increases in wages and prices, according to the report, with supply chain bottlenecks now expected to last longer. Investment intentions and hiring remain high, but so do expected wage costs. The average expected wage increase is now 5.8 percent next year, according to the business survey, a record.
The central bank also raised the risk that consumer spending could be hit by higher inflation, with confidence down and households not expecting wage gains to keep up with inflation.
“Expectations of higher inflation and rising interest rates are weighing on consumer confidence,” the central bank of Canada said. “In response to such factors, Canadians plan to reduce spending. They are looking for more affordable options when they shop.”
A broad gauge of business sentiment fell slightly but remains at historically high levels. The central bank’s composite indicator of business conditions fell to 4.85 from 5.01.
Still, Canada’s central bank said uncertainty surrounding the economic outlook has increased over the past three months.
“Most businesses see this uncertainty as creating risks to their outlook, but not yet further affecting their operations or sales expectations,” it said.
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