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Governor Tiff Macklem takes part in an event at the Bank of Canada, in Ottawa on Oct. 7, 2021. Almost half of the respondents to the bank's survey, published on Monday, now expect inflation to remain above 3 per cent for the next two years, although many say they expect the factors fuelling inflation to be temporary.BLAIR GABLE/Reuters

Canadian businesses are grappling with labour shortages and supply chain disruptions, and many plan to raise wages and pass on cost increases to customers in response, according to the Bank of Canada’s quarterly survey of businesses.

This dynamic is pushing up expectations for short-term inflation. Almost half of the respondents to the survey, published on Monday, said they expect inflation to remain above 3 per cent for the next two years, although many said they expect the factors that fuel it to be temporary. The central bank surveyed about 100 businesses between mid-August and mid-September.

A separate survey of about 2,000 consumers conducted in the second half of August also found elevated short-term expectations of inflation. The median prediction for inflation a year from now was 3.72 per cent, the highest level since the survey began in 2014. Over the longer term, respondents said they expect inflation to be about 3 per cent two years and five years from now.

The surveys land in the middle of a heated debate about inflation and supply chain bottlenecks. Inflation hit an 18-year high of 4.1 per cent in August, and many analysts expect it to tick up again when the consumer price index numbers for September are published on Wednesday. Global supply chain disruptions are driving up shipping costs and commodity prices, and labour shortages are pushing wages up.

The Bank of Canada pays close attention to inflation expectations, which are a major driver of inflation itself, as businesses and workers set prices and negotiate wages based on where they believe consumer prices will go. The results of the two surveys will inform the central bank’s rate decision on Oct 27.

The business outlook survey found Canadian companies optimistic about future sales growth, but experiencing significant capacity constraints. Sixty-five per cent of respondents said they would have “some difficulty” or “significant difficulty” meeting an unexpected surge in demand.

The biggest issue is labour. Although Canada’s unemployment rate remains elevated, at 6.9 per cent last month, companies are having trouble attracting workers. Just more than a third of respondents to the business survey said labour shortages were restricting their ability to meet customer demand. Moreover, 71 per cent of respondents said labour shortages were more intense than a year ago, while only 7 per cent said they were less intense.

Companies pointed to several factors that could be contributing to the tight labour market, including government income supports, health concerns among workers and demographic and technological changes that have led to persistent skill shortages.

“Firms also reported somewhat higher retirement and quit rates among staff compared with pre-pandemic norms, suggesting that a change in workers’ preferences may be affecting the availability of labour. The increased quit rate is consistent with many Canadians reporting a willingness to leave their job voluntarily,” the bank said.

This feeds into plans to raise wages. Fifty-seven per cent of respondents said they expected labour costs to be higher over the next year compared with last year, while only 7 per cent expected them to be lower. Companies said they would pass along increased labour costs to customers.

Reported plans to hire new employees are at a record high, and companies are also planning to increase capital investments. More than half of the respondents said they intend to invest more in machinery and equipment next year than in the previous year.

The central bank’s survey of consumers found improving expectations about the job market. Workers reported a higher likelihood of leaving their job voluntarily, and a lower likelihood of losing their job. At the same time, worker expectations for wage growth remain moderate, despite increasing inflation expectations.

“Although the labour market has been improving, inflation has outpaced wage growth, cutting into households’ purchasing power,” Toronto-Dominion Bank economist Ksenia Bushmeneva wrote in a note to clients. “Clearly, consumers have been taking notice as indicated by a jump in the near-term inflation expectations.

“While households’ finances remain in good shape, cushioned by excess savings and wealth gains, higher prices coupled with shortages of some items, due to supply bottlenecks, could weigh on consumer spending in the coming months,” she wrote.

The two surveys add additional fuel to the inflation narrative heading into next week’s rate decision, where the Bank of Canada is widely expected to further reduce its pace of government bond buying. It may also revise its timeline for potential interest-rate hikes. The bank currently says it won’t start raising rates until the second half of 2022 at the earliest.

When deciding how quickly to wind down stimulus and raise interest rates, the bank has to balance high inflation against worse-than-expected GDP growth in recent quarters. Governor Tiff Macklem said last week that he expects the factors driving up inflation to be transitory, although he said supply chain bottlenecks are more complicated and persistent than the bank previously thought.

Stephen Brown, senior Canada economist with Capital Economics, wrote in a note to clients: “Given signs of stronger wage growth ahead, there is a growing risk that the bank will raise interest rates sooner than we anticipate.”

However, he added, “We are not convinced that it will turn more hawkish as soon as next week,” noting the bank’s emphasis on the temporary nature of the forces driving up inflation and the fact that medium- to long-term consumer inflation expectations are stable.

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