The Bottom Line:

Worries about international trade threats were intensifying for Canadian businesses even ahead of last week’s ‘reciprocal’ tariff announcement that rocked global financial markets.

Business sentiment deteriorated significantly as reported in the Q1 Business Outlook Survey (BOS), with a third of firms expecting a recession in Canada in the next year, up from 15% on average in the prior two quarters.

To be sure, those concerns were already present in the last survey in Q4 although the domestic Canadian demand backdrop at the time was still bright, thanks to earlier Bank of Canada interest rate cuts. That optimism was largely eroded in Q1. Businesses’ demand/sales outlook dimmed, while their investment and hiring plans were either paused or scaled back.

As trade uncertainty mounts, expectations for input price pressure were more prevalent. Most firms expected they’ll be able to pass on those increases by raising selling prices and do so fairly quickly (within six months). Business one-year ahead inflation expectations spiked higher, although their longer-term expectations still appeared better anchored.

To-date, Canadian retaliatory tariff measures have not been enough to cause inflation to spike substantially higher. Canada was also largely spared in the latest round of U.S. reciprocal tariff increases. Still, spillovers from severe supply chain disruptions in the U.S. from dramatically higher tariff rates U.S. imposed on virtually all its trade partners are threatening to further slow growth and raise prices in Canada.

Amidst a highly uncertain backdrop, we continue to expect the Bank of Canada will move cautiously in their upcoming meetings to consider impact on both growth and inflation and the fact that fiscal policy is likely the more suitable first line of defense in response to trade-related economic weakness. Our own base-case forecasts assume the BoC will cut the overnight rate by another 25 basis points in April.

The Details:

  • Sales outlook was dimmer in Q1 and that was despite “most firms not incorporating tariffs in their outlooks at the time of the BOS interview”. Outlook was particularly soft for exporters given expectations for a sharp decline (-30.3% in the next year) in export sales.
  • Negative impact from trade war is expected to be contagious. Expectations for domestic sales were still for them to rise in the next year, although by a much smaller margin (+6.5%) comparing to the increase expected at the beginning of this year (+38.5%).
  • Capacity issues are on the backburner as demand outlook slows – firms reported little issues with meeting current and anticipated subdued demand with existing labour, and are not struggling to hire.
  • Firms’ investment and hiring plans, though, are both weighed down heavily by ongoing trade uncertainty. Employment intentions are below the lows during the pandemic, suggesting more softening in labour market conditions are still to come.
  • Wage growth expectations have broadly continued to ease although the same can’t be said about input and selling prices. In Q1 and for the first time in nearly three years, there were more firms expecting input and selling prices will rise at a faster rate than firms expecting they’ll rise less quickly.
  • Most firms reported price pressures were stemming from Canadian retaliatory measures but some also flagged they have been sharing the U.S. tariff costs in order to maintain market share in the U.S.
  • Near-term inflation expectations among businesses picked up substantially in Q1, to 3.6% over the next year in March from 2.8% in January. Longer-term expectations, including for 2 to 5-year ahead remain somewhat well-anchored, mostly within the 2.5% – 3% range.
  • That’s broadly in line with businesses’ expectations of tariff duration – over 50% of firms expected tariffs will last less than a year, a third of them expected longer than one year while rest were unsure.

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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