Bank of Canada Sees Budding Optimism Despite Weak Demand

(Bloomberg) — Business sentiment is improving in Canada and fewer companies are expecting a recession, taking some pressure off policymakers as they debate when to cut interest rates.

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A new Bank of Canada survey suggests that higher rates continue to weigh on activity, and the outlook for sales is “subdued”. But Canada’s large firms are less concerned about a steep decline in growth.

Soft demand also means inflation expectations from business leaders are easing — they’re becoming more hesitant to raise prices, the survey found, while wage pressures from workers may also be cooling.

But a separate survey showed Canadian consumers’ inflation expectations remain elevated. In fact, they believe the rate of inflation will be above 3%, five years from now.

“Consumers are still signaling that they expect a protracted period of inflation to be riding above the Bank of Canada’s 2% inflation target,” Derek Holt, Bank of Nova Scotia’s head of capital markets economics, said on BNN Bloomberg Television. “That’s a bit of a disturbing sign.”

The central bank’s business outlook indicator rose to minus 2.4 in the first quarter, from minus 3.1 previously. Firms continue to report weakened demand conditions, the bank said, and about 27% of firms expect a recession, down from 37% in the previous quarter.

“These surveys are encouraging for the bank, as inflation expectations are improving (even if slowly), and it looks as though the economy isn’t weakening any further,” Benjamin Reitzes, rates and macro strategist at Bank of Montreal, said in an email. “There’s not enough here to push the bank to cut any earlier, but June is on the table as long as there’s continued progress in the next couple of CPI reports.”

About 56% of firms listed uncertainty as their top concern, up from 52% previously, driven by interest rates, input costs and general domestic economic growth. Worries about cost pressures and demand for sales also continue to rise.

Investment intentions dropped sharply, with just 33% of firms expecting to spend more on machinery and equipment over the next year, down from 41% previously. In addition to uncertainty, firms say soft demand, high borrowing costs and “fewer binding capacity constraints” are limiting investment plans.

Inflation expectations among large Canadian businesses remain elevated but continue to ease, the bank said — 27% of firms expect yearly price pressures to exceed 2% beyond three years, down from 37% in the previous survey done in late 2023.

The labor market continues to loosen and businesses expect wage growth to be 4.1% — slower than it was in the previous 12 months, but higher than historical averages. Just 22% say labor shortages are restricting their ability to meet demand, and 43% of firms say they expect their workforce to expand, up from 37% previously.

“Normalization of wage setting remains a gradual process,” the bank said.

Read More: Early Signals Are Showing Cooling Wage Growth in Canada

Fewer companies are planning to make larger or more-frequent-than-normal price increases.

In the survey of consumer expectations, near-term inflation expectations were little changed from the previous quarter, and remain well above the Bank of Canada’s 2% target for inflation. Progress on long-term inflation expectations has reversed.

With interest rate expectations falling, intentions to buy a home have increased compared to last year despite elevated mortgage costs, high home prices, limited housing availability and considerable difficulty for renters to save for a down payment.

The share of respondents who are planning to buy or thinking of buying a house or condo rose to 15%, from 13% in 2023. The share of renters planning to buy in the next 12 months increased to 18%.

Members of the central bank’s six-person governing council said it was “still too early” to consider lowering borrowing costs at their March 6 rate decision, where they ultimately held the policy rate at 5% for a fifth straight meeting.

Economists surveyed by Bloomberg expect the Bank of Canada to start lowering borrowing costs in June. The central bank’s next meeting is April 10.

(Adds quote from Bank of Nova Scotia economist in fifth paragraph)

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