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This morning’s Q1 Bank of Canada Business Outlook Survey revealed healthier than expected business sentiment and investment/hiring intentions in February and March amid the Middle East conflict, but concerning signs of business inflation expectations edging higher through March.
Taken together, the results are broadly consistent with our expectations for per-capita domestic demand to slowly improve in 2026, absorbing remaining economic slack. The full impact of high oil prices will take time to play out and to date poses no real urgency for the BoC to intervene.
Our base case assumes declining but still elevated oil prices will have a relatively neutral impact on Canada’s economy with limited second-round effects on non-energy consumer prices. We expect the BoC to monitor inflation expectations closely but won’t make a move this year.
Higher oil prices are raising business inflation expectations
Oil prices have settled lower in recent days, but their impact on growth and inflation in Canada remain the key focus heading into the Q1 Business Outlook Survey release this morning.
Last week, Bank of Canada Governor Tiff Macklem commented from Washington that the central bank will monitor medium and long-run inflation expectations closely to guide future interest rate decisions. Those business expectations were largely unchanged in February from Q4 2025, but have ticked higher since then.
According to the Business Leaders’ Pulse survey, firms’ one-year, two-year, and five-year inflation expectations rose by 0.8, 0.6, and 0.2 percentage points respectively between February and late March. By the end of March, expectations ranged from 3% to 4%, up from a more uniform ~3% in February.
The BoC’s March follow-up survey of 20 firms highly exposed to Middle East conflict revealed rising input costs. However, passthrough to consumer prices remains highly uncertain, with firms citing soft domestic demand, elevated competition, and contractual constraints as key barriers.
To track the impact of high oil prices, we will monitor key input price indices—the industrial price index, farm product price index, and import price index—closely. For now, we continue to expect limited second-round effects of higher oil prices on non-energy consumer inflation in Canada this year.
Improving business sentiment amid the Middle East Conflict
Shifting the focus to the more routine quarterly update of forward-looking business sentiment indicators, the survey mostly pointed to a healthy rebound, with the BoC noting that most firms’ outlooks for sales, investment, and employment were roughly unchanged between February and March.
In Q1, 9% of firms surveyed were budgeting for a recession, down from 22% in Q4 and the lowest since 2023. The improvement was amid easing trade tensions. Although rising public spending related to infrastructure and defence projects also supported outlooks.
Most exporters continued to report their exports to the U.S. were tariff-free under the Canada-United States-Mexico Agreement. While firms expected higher tariff rates from the upcoming scheduled joint CUSMA review, few believed this would meaningfully affect near-term plans.
Encouragingly, firms’ investment and hiring intentions both improved to track at or above long-run averages in Q1. These gains reflect expectations for stronger domestic demand among firms unaffected by trade tensions, despite adequate physical and labour capacity.
Some weaknesses in discretionary household spending is expected ahead by both businesses and consumers that participated in the follow-up survey to BOS and the separate Canadian Survey on Business Conditions in March.
Our own tracking of RBC card spending pointed to continued softening in discretionary goods spending in March but resilience in other categories. Households will likely keep draw on savings to weather the near-term impact, before having to scale back spending if oil prices remain elevated for longer.
About the author:
Claire Fan is a senior economist at RBC. She focuses on macroeconomic analysis and is responsible for projecting key indicators including GDP, employment and inflation for Canada and the US.
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