Canadian firms keep investments in check despite rate cut expectations

By Promit Mukherjee, Ismail Shakil

OTTAWA (Reuters) -Canadian businesses expect interest rates to come down by as much as 100 basis points over the next year but their willingness to invest is below average due to a weak demand outlook, the Bank of Canada said on Monday in its second-quarter survey.

Most firms expect their investments would go toward repair and maintenance work, with less emphasis on improvements in productivity, the survey showed. The polling was conducted in April and May, before the central bank's first rate cut in four years last month.

Fewer firms see a mild recession in the next 12 months compared with the previous survey, the Bank of Canada said, adding that firms' expectation for inflation was now in the bank's inflation-control range of 1% to 3%.

The BoC targets 2% inflation - the midpoint of the control range.

Last month, the bank cut its key overnight rate by 25 basis points after keeping it at a more than two-decade high for about a year.

The cut boosted hopes that more rate reductions were coming, though BoC Governor Tiff Macklem has insisted that any future action would be data-dependent, primarily how inflation and economic growth evolve.

The survey showed that the business outlook indicator, which measures business prospects under current economic conditions, weakened to minus 2.9 in the second quarter from minus 2.39 in the first quarter.

"Business sentiment remained relatively flat in the second quarter of 2024," the survey said, adding that it was weighed down by elevated interest rates, weak demand and ongoing high costs.

Inflation in May unexpectedly accelerated after showing a cooling trend in the first four months of this year, while GDP numbers showed that the economy expanded in April and was likely to post another expansion in May.

Some 41% of respondents foresee that inflation would be above 3% for the next two years, a tick higher than the 40% in the previous quarter, while 20% of the firms expect Canada to be in recession in the next 12 months, down from 27%.

However, they see input prices and selling prices increasing at a lesser rate over the next one year.

Statistics Canada will release the Consumer Price Index data for June on Tuesday, a critical data point that could affect chances of a rate cut this month.

"If there are no surprises in the data tomorrow, it should be an easy decision for monetary policymakers to cut rates another 25 bps next week," Royce Mendes, head of macro strategy at Desjardins Group, wrote in a report. He added that the survey reinforces that a rate cut is needed.

Financial markets see over 80% chance of another 25 basis point-cut when the bank makes its July 24 interest rate announcement.

Uncertainty and cost pressures remained the most frequently mentioned concerns of businesses, the survey said.

"Firms mentioned red tape and regulations as slowing their plans, and taxes, predominantly the carbon tax, as increasing their costs," it said.

A weak sales outlook, especially for firms tied to discretionary consumer spending, has softened the demand for additional workers and as a result the expectations of average wage increase in the next 12 months have declined significantly, the survey showed.

A resilient wage growth rate has been a constant irritant for the BoC, impeding the bank's efforts to cool inflation. However, Macklem said last month that wages were starting to moderate.

A separate survey by the central bank on consumer expectations showed that most consumers continue to report spending cuts and pessimism about future economic conditions.

Perceptions of inflation are unchanged from a quarter ago, but consumers' expectations for inflation over the next 12 months have declined significantly, it said.

(Reporting by Promit Mukherjee and Ismail Shakil in Ottawa; Editing by Matthew Lewis)