The Bank of Canada’s latest business outlook surveys, released on Monday, revealed that the Iran war had a dual impact on the economy. It dampened business confidence while simultaneously driving up inflation expectations. This prompted the central bank to introduce new metrics to monitor sales and price activities more effectively in an environment prone to shocks.
Over the past three months, the surveys indicated a rise in input costs and geopolitical uncertainties, particularly affecting sales expectations for most firms outside the oil and gas sector in the Prairies. Concerns about a looming recession surged, with 17% of businesses anticipating an economic downturn in the coming year, nearly double the figure from the previous quarter.
Despite challenges, businesses reported reduced uncertainty related to trade disruptions with the United States. Export outlooks improved significantly due to higher commodity prices and increased demand for artificial intelligence inputs. Inflation expectations spiked in the second quarter, driven by escalating energy prices linked to the Middle East conflict.
The Bank of Canada highlighted that projected price hikes reached a four-year high in the last quarter. Most of the surveys were conducted in May, a period of heightened uncertainty surrounding the Iran war. Subsequent surveys in later weeks showed a peak in inflation expectations in April, followed by a decline after a peace deal was signed in mid-June.
Consumer spending intentions decreased in the past quarter, especially among households bracing for price hikes due to the Middle East conflict. These cautious consumers were observed to seek discounts, reduce driving, and postpone major purchases.
To address the evolving economic landscape, the Bank of Canada is splitting its benchmark indicator into two separate measures. One will focus on firms’ expectations for sales, hiring, and investment, while the other will track input and selling prices, wages, and inflation. This move aims to better capture the diverging signals that shocks like the Iran war can send to the economy.
Senior economist Robert Kavcic from BMO noted that the latest outlook surveys reflected the central bank’s dilemma in recent months regarding interest rate decisions. However, with global oil prices stabilizing, inflation expectations are expected to ease in the current quarter. As a result, the Bank of Canada is likely to maintain its benchmark interest rate at 2.25% during its upcoming decision on July 15.