Bank of Canada Surveys Show War Hitting Inflation Expectations

Tiff Macklem, governor of the Bank of Canada, right, and Carolyn Rogers, senior deputy governor, during a news conference in Ottawa on March 18. Photo by David Kawai /Photographer: David Kawai/Bloomb

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(Bloomberg) — The war in Iran is pushing up inflation expectations, after sentiment had been improving prior to the conflict, survey data released Monday by the Bank of Canada shows.

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Canadian firms consistently hiked their expectations for inflation in the weeks after the war in the Middle East began, according to the data. Meanwhile, more than 80% of households surveyed said they expect the war to harm the Canadian economy and raise inflation. 

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Firms raised their one year-ahead expectations for annual inflation to 3.8% at the end of March, from 3% in February, the bank said. The impact on longer-term inflation expectations was more muted: two-year ahead and five-year ahead expectations rose to 3.4% and 3% respectively, from 2.8%.

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The central bank’s main business and consumer surveys for the first quarter were completed prior to the conflict. However, after the war broke out Feb. 28, the bank made follow-up calls to firms most likely to be impacted by higher energy prices, as well as a subset of consumers. 

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The bank said these follow-ups with firms also “prompted significant shifts” in the outlook for inflation.

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“Most businesses had revised up their expectations for input prices, mentioning specifically fuel, freight, fertilizers and exchange rates,” the bank said, adding that fuel-intensive businesses — including agriculture, oil and gas, transportation and some manufacturing — were already seeing higher prices. 

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At the same time, firms told the central bank that there are barriers to raising prices, leading to a partial pass-through of higher costs. “Changes to selling prices were less common,” the bank said.

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Firms listed a weak demand environment, constrained consumer budgets, competition, pre-existing contracts that limit price adjustments, and limited pricing power as factors limiting pass-through. Businesses also suggested they expect to or already are absorbing “part or all of the increase in their costs.”

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The follow-up surveys match the central bank’s communications from its last decision in March, when policymakers held borrowing costs at 2.25% and said that they would look through the immediate oil price shock. At the time, officials had suggested that firms weren’t as likely to pass on higher fuel costs as quickly because the economy was in excess supply. On Friday, Governor Tiff Macklem said he was less concerned about rising near-term inflation expectations.

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Prior to the war, Canadian consumers’ inflation expectations over the next one to two years were largely unchanged from the fourth quarter and remained above the historical average, according to the central bank’s survey. 

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Canadians had also become less negative about their spending plans. The improvement was concentrated among workers in trade-sensitive sectors, suggesting fading concerns about US tariffs.