Bank of Canada surveys show rising inflation expectations, significantly increasing the chance of rate hikes

People shop at Walmart Supercentre in Toronto on March 13, 2020.Carlos Osorio/Reuters

Canadian consumers and businesses expect inflation to remain elevated for several years, adding pressure on the Bank of Canada to announce another significant rate hike next week to prevent rapid consumer price growth from becoming entrenched.

A pair of quarterly surveys released by the Bank of Canada on Monday, one focused on consumers and the other on business, showed that rising inflation is increasingly subject to Canadian psychology. Short-term inflation expectations among consumers are at a record high, while businesses expect inflation to remain high as they grapple with labor shortages, rising wages and supply chain bottlenecks.

The surveys may provide additional incentive for the Bank of Canada to raise the benchmark interest rate by 0.75 percentage points in its rate decision on July 13 – which would be the largest single increase since 1998. Central bank officials have said during recent public appearances that holding back inflation expectations is Their most important task is in the short term, and they are ready to “act more aggressively” if necessary.

Inflation expectations are the main determinant of actual price increases. Workers demand higher wages and companies set higher prices based on where they think inflation is headed. This can lead to a wage-price vortex, which can make inflation self-reinforcing – a situation the Bank of Canada desperately seeks to avoid.

“The longer inflation remains much longer than our target, the more likely it is to fuel inflation expectations, and the greater the risk that inflation will become self-fulfilling,” Bank of Canada Deputy Governor Paul Beaudry explained in a speech last month.

“History shows that once high inflation is entrenched, bringing it back down without severely crippling the economy is difficult. Preventing high inflation from becoming entrenched is much more desirable than trying to eliminate it once it has occurred.”

Canada’s annual inflation rate reached 7.7 percent in May, the highest rate since 1983.

The consumer survey, conducted from late April to mid-May, found that the average respondent expects inflation to be around 7 percent next year and around 5 percent within two years. This is well above the central bank’s 2 percent inflation target.

Perhaps most worrying for the Bank of Canada is the fact that long-term consumer inflation expectations are on the rise after being well contained for the past two years. Respondents expect 4 percent inflation within five years. That’s up from 3.2 percent in the previous consumer survey, published in April.

The central bank noted in the survey publication that inflation concerns vary with demographics. Low-income Canadians and the elderly tend to worry about rising rent and groceries prices, while young people are more likely to worry about housing prices.

The survey found that Canadians do not expect their wages to keep pace with inflation, and that many people, especially those on lower incomes, are already changing spending habits and putting off big purchases.

“People now often shop to find better prices, and stock up on items for sale. Some consumers reported sticking to a tight budget for groceries by buying more generic products or not buying items considered less important. The Bank of Canada noted that some rely more on groceries. Gardening for food or using cheaper forms of commuting, such as cycling.

There was a potential bright spot: The central bank said confidence in its ability to meet its 2 percent inflation target was unchanged materially from before the pandemic, despite rising inflation. About 42 percent of respondents believe the Bank of Canada can meet its inflation target all or most of the time, compared to about 45 percent in 2019.

The survey of businesses, conducted in mid-to-late May, found that nearly a third of respondents think inflation will remain well above 2 percent for two to three years, while 22 percent think it will remain high for three years or more. more. Years.

Companies are dealing with significant labor shortages, as well as ongoing supply chain constraints, and plan to pass on higher input costs to customers. The Bank of Canada said in the survey post that these are signs of “excess demand” in the economy.

42 percent of companies said they are struggling to find enough workers to meet demand for their products and services. Many are responding by increasing compensation: Survey respondents expect wages to rise at a rate of 5.8 percent over the next year, a record high.

An increasing number of companies have cited the rising cost of living as an important source of wage growth. Nearly half of companies expect wage increases to remain above pre-pandemic levels after the next 12 months,” the Bank of Canada said.

The surveys add to the argument for a aggressive rate hike next week by the Bank of Canada, according to Bank of Montreal economist Shelly Kochik.

“Historically high inflation pressures remain, although there are some indications that resilient consumer demand can help companies weather increasingly hazy expectations,” Kaushik wrote in a note to clients.

However, the continued rise in inflation expectations only strengthens our expectations at .75 [basis point] Lift at next week’s policy meeting. “

The bank has increased its policy rate in three consecutive meetings, including two moves of 50 basis points. The standard rate is currently 1.5 percent. Central bankers said they may need to move it to 3 percent or more to deal with inflation.

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