Iran Conflict Dampened Business Confidence, Raised Inflation Outlook: Bank of Canada

A view of the Bank of Canada building in Ottawa on May 8, 2025. Reuters/Blair Gable/File PhotoThe effects of the war in Iran undermined business confidence and led to a sharp increase in inflation expectations in the second quarter, the Bank of Canada’s most recent business outlook survey suggests.A rise in input costs and geopolitical uncertainty linked to the conflict has also lowered sales expectations for most businesses outside the oil and gas sector in Western Canada, the findings show. At the same time, inflation expectations increased sharply among those surveyed.Most of the interviews conducted by the Bank of Canada were in May, a period of heightened uncertainty surrounding the war. Subsequent interviews showed that inflation expectations peaked in April and continued to decline following the signing of a peace treaty in mid-June.The bank’s second-quarter survey doesn’t make for “a comforting read on the Canadian economy,” but it’s worth noting the survey was conducted from May 1 to 21, before uncertainty surrounding the U.S.-Iran conflict intensified, BMO senior economist Robert Kavcic said in a recent note to investors.“Suffice it to say that some of the concerns over growth in this report and, especially on inflation, should be behind us,” Kavcic wrote.Recession and TradeThe percentage of businesses anticipating a recession in the coming year rose to 17 percent in the second quarter, nearly double the 9 percent observed in the prior three months, the survey found.“Even so, this share remains below the levels seen throughout 2025,” the bank noted.Businesses were reporting reduced uncertainty associated with trade disruption with the United States, the survey found. The bank said the forecast for exports has risen significantly above historical averages, driven by increased prices for commodities like oil and metals and growing demand for goods and services tied to the construction of artificial intelligence (AI) data centres in the United States.Ongoing trade tensions and associated uncertainty persist in impacting companies’ projections for domestic sales, primarily through indirect consequences like weakened consumer confidence and decreased expenditure by businesses in sectors affected by tariffs, the report found.“Outlooks are particularly weak among firms in the housing sector, which also face slow population growth, affordability challenges and geopolitical uncertainty,” it said.Consumer ExpectationsConsumer inflation expectations have also risen, with an increasing number of participants attributing this to energy prices, according to a separate survey of consumers by the central bank.Consumer spending intentions declined slightly in the last quarter, especially among households anticipating that the conflict in the Middle East will raise prices, the bank said.Beyond the war in the Middle East, many consumers also pointed to trade tensions as a factor in rising prices and economic uncertainty.“Most consumers—though fewer than last quarter—continue to believe that the most serious effects of trade tensions are still ahead,” the bank said.Survey respondents said they were looking for discounts at the grocery store, driving less, and holding off on major purchases.Kavcic said the most recent set of outlook surveys shows the Bank of Canada in recent months has been torn between the need for lower rates to stimulate economic activity and the need for higher rates to combat inflation.“Lower oil prices should help dial these concerns back in Q3. All in, we still see the Bank of Canada firmly on hold this year,” he wrote.The consensus among analysts suggests that the Bank of Canada is likely to keep its benchmark interest rate unchanged at 2.25 percent when it announces its decision on July 15.The Canadian Press contributed to this report.