Businesses and consumers alike are trimming their spending plans as higher interest rates bite and a possible recession looms, according to new surveys from the Bank of Canada.
The central bank’s fourth-quarter surveys of business and consumer sentiments, published Monday, showed an overall dour outlook for 2023, with the majority of both polled cohorts indicating they expect a recession in the next 12 months.
Businesses are expecting sales to slow down for the fourth consecutive quarter, citing concerns about the impact of high interest rates on both their operations and consumers’ spending plans.
Still-high inflation, especially when it comes to food, is forcing Canadians to rein in household spending, the surveys showed.
High interest rates are especially hurting consumers with variable-rate mortgages or other kinds of debt, according to the Bank of Canada. Respondents to the survey indicated high rates were forcing them to put off larger purchases or cut down on recreational spending.
What do the surveys say about inflation expectations?
Inflation expectations from both consumers and businesses are still relatively high for the next year, with labour market pressures, the war in Ukraine and elevated energy prices fuelling that belief.
However, a majority of both consumers and businesses expect inflation to return to the Bank of Canada’s target of one-to-three per cent within five years, the surveys showed.
The central bank has said in its own forecasts it expects inflation to return to target by the end of 2024.
Businesses are reporting that two major source of inflations, global supply chain bottlenecks and labour shortages have shown signs of improvement in the past three months.
“Although still above pre-pandemic levels, the number of businesses reporting labour and supply chain bottlenecks as obstacles to meeting an unanticipated increase in demand has declined,” the bank wrote in its report. “This suggests that the gap between demand and supply is narrowing.”
Businesses expect slower price growth as global commodity prices and consumer demand drop.
The bank’s surveys suggest businesses expect they’ll be able to return to “pre-pandemic practices” for pricing.
“This includes reducing the size and frequency of price increases compared with the past 12 months,” the bank said in its report.
Businesses have faced pressure to raise wages in Canada’s tight labour market over recent months, but the bank’s surveys show that may be easing.
While wage growth expectations remain above pre-pandemic levels, fewer businesses than last quarter said they are raising wages faster to retain workers, according to the surveys. Hiring intentions have also moderated.
What does this mean for interest rates?
The central bank uses quarterly surveys of business and consumer sentiment, alongside other economic data, in deciding where to take its benchmark interest rate, which currently sits at 4.25 per cent after a cumulative increase of 400 basis points in 2022.
While the story for much of last year was not a question of if the central bank would raise rates, but how much, policymakers left the door open to a pause starting in 2023. Future interest rate decisions will be “data dependent,” the bank said in December.
Inflation expectations are as much a data input for the central bank as inflation itself, experts say.
Randall Bartlett, senior director of Canadian economics at Desjardins, told Global News in a recent interview that when the central bank sees easing growth expectations for both inflation and wages, that’s a sign it can consider pausing interest rate hikes.
“When all of those things start to come together, that’s when we’ll start to get a prolonged pause by the bank,” he said.
CIBC Executive Director of Economics Karyne Charbonneau said in a note to clients Monday morning that the expectations data in the Bank of Canada’s latest surveys should give policymakers some leeway at their next interest rate decision on Jan. 25.
“With no worsening of the situation on the expectations front, that leaves the Bank of Canada with the space to focus on incoming data in determining the path for interest rates,” she wrote.
Like many big bank economists in Canada, Charbonneau expects the central bank will raise rates another quarter of a percentage point next week. She added the caveat that unexpectedly high inflation readings on Tuesday or stronger than expected retail figures released Friday could push the Bank of Canada to take a larger step with its benchmark rate.
What does this mean for a recession?
In the same way that expectations for inflation can have a tangible impact on price growth itself, Bartlett added that believing a recession is coming can be a self-fulfilling prophecy.
Canadians have heard a growing chorus of economists, policymakers and other commentators in the media warn of a recession for months now, and that rhetoric can push consumers and businesses alike to rein in their spending plans, he said.
With businesses reducing their spending, investment and hiring plans in response to economic headwinds, the ingredients for a recession and a pronounced slowdown in gross domestic product (GDP) becomes all the more likely, according to Bartlett.
“As more constraint is shown by households and businesses in terms of investment and spending and that sort of thing, ultimately that tends to weigh on economic activity and reduce real GDP growth in a broad-based way,” he said.
Desjardins, like some other economic forecasters, has called for Canada to face a mild recession in 2023.