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The Q2 Bank of Canada Business Outlook Survey was conducted in May amid high oil prices due to conflict in the Middle East. Against that backdrop, results reflected the expected rising price expectations but stable longer-run (5-year) inflation expectations among businesses, as well as overall resilient sales and investment expectations at the time.
The separate Canadian Survey on Consumer Expectations (CSCE) showed energy prices cutting more significantly into household spending plans in Q2. But global oil prices have normalized significantly since mid-June, alleviating concerns about both secondary inflation impact and domestic demand destruction from previously high energy prices.
With economic growth picking up in Q2 after Q4-Q1 stagnation, and core inflation pressures remaining subdued in latest May, the case for BoC to move in either direction is weak. We continue to expect the central bank will opt to leave interest rates unchanged through 2026.
Price indicators surged in Q2 when oil prices were high
The Q2 BOS survey period was conducted between May 7 and 21, during which prices for West Texas Intermediate (WTI) crude oil averaged US$101/bbl.
Unsurprisingly, all indicators related to prices, including expectations for non-labour input and their selling prices, rose substantially as a result. 40% of firms reporting cost increases due to the war in the Middle East were not passing those increases on to their customers, 25% are partially passing them on, and a third are passing them fully.
The share of firms reporting cost pressures separately from tariffs and trade policies have actually declined since Q1, though those affected still expect pressures to persist through the supply chain.
Recently lower oil prices have led inflation expectations lower
The monthly Business Leader’s Pulse (BLP) survey showed business inflation expectations fell sharply after oil prices moved off of April/May highs in June.
Firms’ 1-year ahead inflation expectations dropped from 3.9% in April to 3.3%, slightly above 3% before the Middle East conflict in February. Two-year ahead expectations normalized fully to match February’s 2.8% in June, while five-year ahead expectations remained anchored through the period of high oil prices.
To date, we continue to track little signs of high oil prices spreading to raise non-energy consumer prices in Canada. The scope of inflation pressures remained well-contained in April despite rising headlines. Global jet fuel and urea fertilizer prices have moderated as well, the former still broadly above year-ago levels but the latter now below.
Activity indicator remained robust while investment plans firmed again
What was more surprising was the degree that activity indicator held firm over the Q2 survey period despite surging price expectations at the time — edging down very slightly to retrace the gain in Q1. On Balance, firms reported rising past sales levels, but expected slightly slower sales growth in the future.
Encouragingly, business investment intentions strengthened again in Q2 to mark the strongest first half of year since 2022. The Bank of Canada reported stronger intentions were especially prevalent among firms in the natural resources sector and ones that are linked to public spending.
Hiring intentions weakened in Q2, consistent with reports of limited capacity constraints or reduced binding labour shortages in the quarter.
Consumer spending intentions softened but actual spending still resilient
The other key question around the impact of elevated oil prices outside of inflation is the degree of consumer demand destruction as elevated gasoline prices cut into their purchasing power.
In the Q2 BOS survey, reduced discretionary spending was cited among firms with a poorer sales growth outlook in Q2. That was echoed by weaker spending intentions reported in the Q2 Consumer Survey, although the government’s one-time groceries and essentials benefit top-up payments were expected to support spending among those who qualify.
Our own spending tracker from RBC card purchases suggests some ongoing resilience in household purchases, however, with retail spending ex-gasoline edging higher in May. As oil prices moderate, we expect overall spending destruction to be limited, but with lower-income households particularly impacted by rising essential prices.
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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