Sentiment among Canadian firms is at its lowest since the Covid-19 pandemic started and inflation expectations remain elevated, according to surveys conducted by the Bank of Canada. The central bank’s business outlook indicator fell to 0.07 in the fourth quarter, from a revised 1.74 previously. About 70% of businesses see the economy heading into a recession, and more firms than usual expect their sales to decline. Higher interest rates and inflation have also limited the ability of consumers to spend, the bank said in a separate survey.
The data suggest that the Bank of Canada may not need to increase interest rates much further in order to bring demand and supply back into balance, and that last year’s aggressive hikes are already working to slow growth. Toronto-Dominion Bank strategists Andrew Kelvin and Robert Both said in a report to investors that “the survey data very much suggests that the bank may be quite close to the end of its tightening cycle.” However, they also noted that “the bank can ill afford a premature pause in 2023.”
The majority of workers do not expect their earnings to catch up with recent price pressures, and about half of households think they will be negatively affected by a potential recession. About half of consumers who expect a downturn think it will be moderate in severity and length, while 90% of businesses expect it to be mild.
Governor Tiff Macklem and his officials have slowed down the pace of rate hikes and signaled that future decisions will depend on economic data. The central bank has already raised borrowing costs by 4 percentage points since last March, bringing the benchmark overnight rate to 4.25%. The surveys and December’s inflation report from Statistics Canada are the final major inputs into the central bank’s January 25th policy decision. Traders in overnight swaps markets were putting the odds of a 25-basis-point hike at more than 80%.
The yield on benchmark two-year Canada bonds was at 3.586% as of today, down 8 basis points from Friday’s close and slightly below its trading level before the survey release.
The contrast between the deteriorating business outlook and a recent string of stronger-than-expected economic data complicates the bank’s policy response. While the headline annual inflation rate eased in November, underlying price pressures trended higher. Early estimates suggest the economy is on track to expand at an annualized rate of 1.2% in the last quarter of 2022 — more than double the Bank of Canada’s forecast. Last month, the labor market blew past expectations and added more than 100,000 jobs, while the unemployment rate fell to near a record low of 5%.
Four out of Canada’s six biggest banks now expect another rate hike from Macklem, with Canadian Imperial Bank of Commerce and Royal Bank of Canada changing their forecast after the blowout jobs report.
The situation in Canada reflects a global trend of rising inflation and interest rates, which has led many companies to become bearish on the economy. The Bank of Canada’s survey results underscore this sentiment, with a significant number of businesses expecting a recession and declining sales. The central bank’s decision to slow down the pace of rate hikes and signal that future decisions will depend on economic data suggests that policymakers are aware of the negative impact of high interest rates and inflation on the economy.
However, despite this, the outlook for the Canadian economy remains uncertain, as strong economic data and rising inflation pressures continue to complicate the central bank’s policy response. It will be important for policymakers to closely monitor economic indicators and respond accordingly to ensure that the economy remains stable and growth is not hindered.