RBC on the central bank's top considerations
The Bank of Canada’s latest Business Outlook Survey pointed to signs of softening in the economic landscape as consumer demand contracted further in the fourth quarter, according to RBC Economics.
A marked decline in business sentiment was accompanied by a shift towards demand-related factors, including economic uncertainty, insufficient demand, and access to credit, RBC said. This was a departure from challenges such as supply chain issues or labour shortages that were prominent in the central bank’s earlier assessments.
“The BoC has been paying particularly close attention to business pricing behaviour and wage growth expectations for signs that slowing domestic inflation trends will persist, and both showed improvement in Q4,” RBC said.
The central bank noted that the proportion of businesses planning larger-than-normal price increases for the next year fell from 42% in Q3 to a still-elevated 37% in Q4. RBC cited competitive pressure and a softened consumer demand environment as major factors constraining businesses from passing on abnormal price increases to consumers.
“Softer demand also means labour markets are easing,” the BoC said in its outlook. “Most firms do not feel the need to add new staff and are experiencing less-intense labour shortages than 12 months ago.”
“Still, wage growth on average is expected to be higher than normal over the next 12 months, often related to cost-of-living adjustments. Wage growth expectations are gradually declining, however, as fewer businesses adjust wages for past cost-of-living increases and as demand for labour eases.”
Citing the central bank’s forecasts, RBC said that wage growth is anticipated to slow “only gradually” to 4.1% for the next year, still exceeding the 3.2% historical average rate.
The latest inflation readings support the validity of the Bank of Canada’s cautious approach towards potential interest rate cuts, according to RBC Economics.
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During the fourth quarter, Canadian businesses’ optimism about future sales was not mirrored by consumers, as many households actually reported an increase in financial stress.
“Over two quarters of consumers suggested that they have either already or were planning to cut spending, in light of expectations for impact from rising interest rates,” RBC said. “Inflation expectations have eased among both Canadian businesses and consumers in Q4, but only marginally.”
“At 3.9%, consumers’ expectation for inflation over the next two years also continued to outpace that of businesses at 3.2%. Longer-term inflation expectations appeared to be much better anchored, at 2.6% each year over the next five years for consumers, and 2.5% for businesses.”
RBC note that the BoC’s close monitoring of firm pricing and wage growth will give the central bank valuable data, especially when it comes to indicators that the recent slowdown in inflation will persist.
“That for the most part confirms the cautiously optimistic view among BoC officials that interest rates are high enough for now,” RBC said. “Inflation readings are still too firm to justify immediate rate cuts from the central bank, but we look for a softer economic backdrop and further easing in price pressures will push the BoC to pivot to gradual rate cuts by mid-year.”
