Downbeat Bank of Canada business and consumer surveys raise odds of second rate cut

Downbeat businesses and consumers expect the Canadian economy to remain in the doldrums and inflation to continue to decline, according to a pair of Bank of Canada surveys published Monday, bolstering the case for another interest-rate cut at the central bank’s next rate announcement on July 24.

The bank’s quarterly survey of businesses found subdued expectations for future sales, easing cost pressures tied to wages and little interest in hiring or investing in machinery and equipment. This pessimistic view is feeding into how much companies plan to raise prices, as well as their forecasts for inflation.

“Businesses expect the growth of their input prices and selling prices to slow, suggesting that inflation will continue to decline over the coming year,” the Bank of Canada said, noting that most companies now think inflation will be within the bank’s 1-per-cent-to-3-per-cent control range over the next few years.

Individual expectations for near-term inflation also “declined significantly,” according to the bank’s consumer survey, after stalling for several quarters.

The surveys, conducted in late April and May, with follow-ups in June, are the second-last major piece of information the central bank will receive ahead of its interest-rate decision in a little more than a week. Statistics Canada will publish June inflation data on Tuesday.

Last month, the central bank began the long-awaited process of easing borrowing costs, lowering its policy interest rate to 4.75 per cent from 5 per cent. Since then, the economic data have been mixed, with the annual pace of Consumer Price Index inflation rising unexpectedly to 2.9 per cent in May from 2.7 per cent in April.

“We believe the more downbeat tone from business and consumer sentiment will allow the BoC to look through the upside surprise on the May CPI report,” Toronto-Dominion Bank rate strategists Robert Both and Andrew Kelvin wrote in a note to clients.

“The Bank has a long history of moving back-to-back after a pause, and we believe further erosion of business sentiment and some progress on inflation/wage expectations support another rate cut in July.”

Interest-rate swap traders increased their bets on another rate cut after the surveys were published. Financial markets are now pricing in a roughly 80-per-cent chance that the BoC cuts its policy rate by a quarter of a percentage point on July 24, according to Refinitiv data.

The two surveys contain important information for the central bank. Monetary policy makers pay close attention to inflation expectations, as beliefs about prices can become self-fulfilling. They’re also watching for signs of wage pressure and other signals about how businesses are handling the high-interest-rate environment. The bank is purposefully slowing down the Canadian economy with high interest rates in an effort to anchor rising prices.

The business survey found Canadian companies in a dour mood. Fewer firms said they expect a recession over the next year, compared with previous quarters. But many expect sales to be weak, especially those selling discretionary goods and services. And few seem to have much interest in investing in equipment or hiring new workers at the moment.

“Weak demand, elevated interest rates, uncertainty about the business environment and the high cost of machinery and equipment were cited as discouraging investment,” the bank said.

It also noted a sharp uptick in companies citing taxes and regulation as one of their top concerns. It made no mention of recent changes in tax policy, but the survey was conducted shortly after the federal government announced an increase in the capital-gains tax inclusion rate for businesses and some individuals.

While the mood remains grim in corporate Canada, there are signs the economy is beginning to rebalance after a period of extreme disruption. Fewer firms are experiencing supply chain problems, and the share of companies reporting labour shortages has fallen sharply.

Business expectations about future wage increases are now approaching prepandemic norms, as the rate of unemployment has risen to 6.4 per cent from a 2022 low of 4.8 per cent. Slower wage growth would be positive for businesses trying to control costs and central bankers trying to control price increases, although not for workers hoping to see their earnings catch up with inflation.

The consumer survey captured the strain individuals and households are feeling. Most consumers continued to report cutting back on spending, and many remained pessimistic about the future of the economy, the bank said.

“The upshot is that the quarterly surveys add to the evidence that monetary policy is now too tight,” Stephen Brown, deputy chief North America economist at Capital Economics, said in a note to clients.

“Absent a big upside surprise in the June CPI data … the Bank is likely to cut again next week.”