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Rona CEO Robert Sawyer said inflation is expected to come.

Fred Lum/The Globe and Mail

A declining Canadian dollar is keeping many retail executives awake at night as they grapple with rising costs that could force them to increase prices – and scare away customers.

That's the takeaway from an internal Retail Council of Canada survey that forecasts overall sales gains in 2015 but "impossible cost pressures" as a result of a weak loonie that could squeeze profit margins.

The research found 70 per cent of respondents said last month they would have to raise retail prices by between 1 and 5 per cent, "with most mentioning increases toward the top end of the range," the report said. Another 18 per cent expect price increases of more than 5 per cent.

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Retailers buy much of their inventory overseas or south of the border in U.S. currency, which has strengthened considerably in the past year, making imported goods more expensive. The value of the Canadian dollar has dropped almost 16 per cent against the greenback since the start of 2014.

"In the Chinese calendar, this may be the year of the sheep, but for retailers it will be the year of the roller coaster, if not the house of horrors," said the report, which is meant for council members only and was obtained by The Globe and Mail.

The dollar's devaluation comes amid sagging oil prices, which threaten to hurt business in once fast-growing retail markets, such as Alberta.

Domestic merchants anticipate a bit of relief from the impending exit of rival Target Canada. Consumers are also likely to go cross-border shopping less often and will benefit from cheaper gas.

But retailers cannot ignore the harsh realities of a weaker loonie. Many were counting on riding it out last year, turning a deaf ear to suppliers' warnings of higher wholesale prices tied to the depreciating dollar, said Augustin Manchon, a veteran pricing specialist and president of consultancy Manchon & Co.

Vendors are now pushing through higher prices, and retailers are expected to pass on the increases to shoppers, he said. "Consumers are going to feel it soon – in some categories, it's going to be dramatic," he said, referring specifically to flights, vacation packages, cars, clothes and food.

Home improvement retailer Rona Inc. hasn't implemented price increases because of the exchange rate but that will change soon, chief executive officer Robert Sawyer said last month.

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In the coming season, "yes, there's going to be inflation," he told analysts. "But today, we cannot feel a huge amount of price change at store level. … For sure, it's going to come, but we didn't feel it yet."

Mastermind Toys, the country's largest specialty toy chain, expects to raise some prices between 1 and 5 per cent, mostly in the lower end of the range, president Humphrey Kadaner said.

Mastermind's economies of scale help give it an edge in negotiating with suppliers for better prices or even improvements in products, he said. It recently raised the price of its Rainbow Loom kit almost 12 per cent to $18.99 from $16.99 last year. At the same time, the supplier upgraded the product by replacing the plastic hook with a more functional metal-tipped one, a change the retailer had encouraged, he said. The chain purchases about one-third of its merchandise in U.S. dollars, he said.

Dean McCann, chief financial officer of Canadian Tire Corp. Ltd., also referred to the "headwinds" of the weaker loonie, noting that a sustained drop in value "can be expected to have an increasing impact over 2015."

"We expect to be impacted by the effects of the decline in the Canadian dollar, but the degree is difficult to predict and I'm certainly no economist," he told analysts last month. "That said, we know that, like all retailers buying products overseas, we will have to factor the higher exchange costs into decisions about procurement, pricing and supply chain."

Mr. McCann said the company's hedging would help offset the pain of a weaker loonie while other factors would come into play in determining profit margins. "Our merchants have done a very good job managing all the inputs into cost and margin to date."

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Already, food prices have seen sharp gains, although not only because of the dollar. Overall consumer prices rose 1 per cent in January from a year earlier, with food inflation up 4.6 per cent, the largest gain since November, 2011, Statistics Canada said.

"At some point, we expect some cost inflation pressures," Eric La Flèche, CEO of grocer Metro Inc., said in late January. "We will be treated fairly by the suppliers and we will be competitive."

The council's report said retailers expect to raise prices mostly in the second half of 2015, which could "amplify the trend toward online shopping, where price is the critical variable."

Some merchants are considering ways to skirt the problems, such as changing their product mix, specifications or suppliers, it said. Some are considering purchasing renminbi to pay for their Chinese goods. For now, "the outlook for margins is gloomy, driven by the devaluation of the dollar," the report said.

Mr. Manchon said that to soften the blow of price hikes, many companies are reducing package sizes or the amount contained in each one.

Research shows consumers are generally more sensitive to price changes than to changes in the quantity of goods, he said. For example, suppliers shrink the depth of a package while the height and width remain unchanged, so the silhouette of the package looks the same on the shelf, he said.

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Other ways to try to disguise a price increase in a smaller package are by using new descriptions such as "more portable" (smaller bags for takeout), "greener" (lighter for the environment) or "healthier" (fewer calories), Mr. Manchon said.

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