The Bank of Canada has released new survey data indicating that the ongoing conflict in Iran is exerting upward pressure on inflation expectations among Canadian businesses and consumers. This marks a reversal from improving sentiment observed prior to the outbreak of hostilities, highlighting the war's disruptive economic influence.
Survey Data Reveals Significant Shifts
According to the central bank's findings, Canadian firms consistently increased their inflation forecasts in the weeks following the start of the Middle East war. The data shows that one year-ahead expectations for annual inflation rose to 3.8 percent by the end of March, up from 3 percent in February. Longer-term expectations also edged higher, with two-year and five-year ahead projections climbing to 3.4 percent and 3 percent respectively, from previous levels of 2.8 percent.
Consumer Concerns Mount
More than 80 percent of households surveyed expressed concern that the Iran conflict would harm the Canadian economy and contribute to rising inflation. This widespread apprehension among consumers underscores the broader economic uncertainty generated by geopolitical tensions.
Follow-Up Surveys Capture Immediate Impact
The Bank of Canada's primary business and consumer surveys for the first quarter were completed before the conflict began on February 28. However, the central bank conducted follow-up calls with firms most vulnerable to energy price fluctuations, as well as a subset of consumers, to gauge the war's immediate effects.
These follow-up surveys revealed significant shifts in inflation outlooks. Most businesses reported revising upward their expectations for input prices, specifically mentioning fuel, freight, fertilizers, and exchange rates. Fuel-intensive sectors including agriculture, oil and gas, transportation, and certain manufacturing industries were already experiencing higher prices.
Limited Price Pass-Through Observed
Despite rising input costs, firms identified several barriers to increasing their selling prices. Businesses cited weak demand environments, constrained consumer budgets, competitive pressures, pre-existing contracts limiting price adjustments, and limited pricing power as factors restricting their ability to pass through higher costs.
The bank noted that changes to selling prices were less common than adjustments to input cost expectations. Many businesses indicated they expected to absorb part or all of their increased costs rather than passing them along to consumers.
Central Bank's Policy Context
The survey findings align with the Bank of Canada's communications following its March policy decision, when policymakers maintained borrowing costs at 2.25 percent. At that time, officials indicated they would look through the immediate oil price shock, suggesting that firms in an economy with excess supply would be less likely to quickly pass on higher fuel costs.
On Friday, Governor Tiff Macklem expressed reduced concern about rising near-term inflation expectations, reflecting the central bank's assessment that the economic impact might be contained despite survey indications of heightened expectations.
Pre-Conflict Baseline
Prior to the Iran conflict, Canadian consumers' inflation expectations over the next one to two years remained largely unchanged from the fourth quarter and continued to exceed historical averages. Interestingly, Canadians had become less negative about their spending plans before the war, with improvement concentrated among workers in trade-sensitive sectors, suggesting fading concerns about U.S. tariffs.
The Bank of Canada's comprehensive survey data provides crucial insights into how geopolitical events can rapidly alter economic expectations, even when actual price transmission mechanisms face significant constraints in the current economic environment.
