EconoFACTS

July 04, 2022 | 12:21

What's the Name of the Game? Inflation

Economist

Economist
Economics

Shelly joined BMO Economics in 2020 and conducts research on U.S. regional economies. She also provides support ... (Read more)

Shelly Kaushik

Economist
Economics

Shelly joined BMO Economics in 2020 and conducts research on U.S. regional economies. She also provides support ... (Read more)

The Bank of Canada’s Q2 Business Outlook Survey reflected higher uncertainty stemming from hot inflation and a fast-tightening monetary policy. The survey was taken from mid- to late-May, amid a more aggressive policy stance from the BoC and ongoing broad-based price pressures. The Business Outlook Indicator edged down to 4.85 (from an upwardly revised 5.01 in Q1), remaining near the all-time high posted in 2021Q4.

Inflation expectations jumped again in this survey, with the proportion of respondents expecting inflation to be above 3% over the next year hitting a fresh record high of 78%. Most businesses expect inflation to remain above the BoC’s target on average for at least the next two years—despite the Bank’s shift to a more aggressive tightening stance in the spring. The good news is that long-term expectations remain stable, at 2.6% in five years. To get back to target, respondents cited a number of conditions that would need to be met, including higher interest rates, improved supply chains, lower oil prices, and an end to the conflict in Ukraine.

Capacity pressures remained elevated with 78% of respondents reporting some or significant difficulty meeting demand (down slightly from the record high of 81% in Q1). Supply chain bottlenecks continue to be a concern, with many firms reconfiguring their supply chains and/or holding more inventory to cope. About half of businesses expect supply chain issues “to persist until the end of 2023 or beyond”.

The percentage of respondents reporting labour shortages ticked up 2 ppts to 42%, while the intensity of shortages rose 1 ppt to 63%. Hiring intentions remain elevated, but competition among businesses has led to higher wages to attract and retain workers. Wages are expected to rise by a record-high 5.8% on average, with most firms citing the rising cost of living as an important source of wage growth. Looking ahead, we expect upward wage pressures to become a bigger theme in the second half of the year.

Future sales growth deteriorated further, falling 15 ppts to a very weak -26% as businesses look beyond reopening gains and labour shortages are expected to limit growth. Still, indicators of future sales (order books and sales inquiries) ticked up. Slowing sales growth was concentrated in sectors that boomed during the pandemic (e.g. housing, natural resources, and transportation). Meantime, high-touch service sectors expect an acceleration in sales growth.

As we’ve said many times before, many of these capacity issues stem from demand outstripping supply. It is this strength in demand that has helped prop up investment intentions, which remained elevated at 37% in Q2. And, while “a few businesses” cited that higher prices for capital goods and higher interest rates may weigh on their investment plans, they noted that these factors are not yet holding them back.

Given the higher commodity price environment, the BoC conducted a separate consultation with oil and gas firms and analysts. While participants reported a positive outlook on the sector, they noted lower investment in new projects compared to previous commodity price booms. Financial discipline, the low-carbon transition, long-term pipeline capacity concerns, and labour shortages and supply chain bottlenecks were all cited as reasons for the modest growth in capital investments over the medium term.

And finally, the balance of opinion on credit conditions tightened 10 ppts to 16% after the Bank switched to a more aggressive rate hike path in the quarter.

Separately, the Survey of Consumer Expectations reiterated many of the same concerns about broad-based inflationary pressures. Inflation expectations rose across the board, hitting fresh record highs over almost all time horizons: current perceptions (6.1%); and, expectations in one year (6.8%), two years (5.0%), and five years (4.0%). The latter is particularly concerning, as it indicates long-term expectations may become unanchored from the Bank’s target; that said, it remains below the high of 4.3% hit in the pre-pandemic days of 2018Q2. The survey noted that consumers perceive inflation to be more pervasive and driven by more persistent factors (supply chain issues, the pandemic, and elevated government spending) than in previous quarters. While expectations of future spending growth remain high (at 4.9%), even larger expected price growth means that spending volumes will likely decline.

Bottom Line: The BOS continues to highlight concerns about broad-based price increases in Q2. Inflation pressures remain historically high, though there are some indications that resilient consumer demand can help businesses weather the increasingly cloudy outlook. Still, the persistence of rising inflation expectations only reinforces our expectations for a 75 bp hike at next week’s policy meeting.

Table 1 - Bank of Canada — Business Outlook Survey

(balance of opinion : greater minus lesser : %)

Source: BMO Economics, Haver Analytics, Bank of Canada