By Julie Gordon and Ismail Shakil
OTTAWA (Reuters) -Business sentiment has softened in Canada and most firms now think a recession is likely, a Bank of Canada survey showed on Monday, but inflation expectations remain high, leaving the central bank little choice but to continue raising rates.
The bank's Business Outlook Survey showed 77% of firms see price growth staying above 3% for the next two years. A separate survey showed near-term consumer inflation expectations at record highs, though longer term expectations have eased, providing some relief.
"Still-high expectations for inflation will keep the Bank of Canada in rate hike mode," said Andrew Grantham, senior economist at CIBC Capital Markets, in a note.
Consumers' lack of confidence that rate hikes will reduce inflation means "workers will be doing everything they can to negotiate higher wages to offset rising prices," said Royce Mendes, head of macro strategy at Desjardins Group, in a note.
That is cause for concern for the central bank as it seeks to avoid a wage-price spiral, analysts said.
The more the Bank of Canada has to increase rates to temper persistent inflation and keep expectations in check, the greater the chance that it will trigger a recession.
The central bank has already hiked its policy rate by 300 basis points since March and money markets are betting on another half a point increase to 3.75% on Oct. 26. Rates are now seen peaking between 4.25% and 4.5% next year.
Canadian inflation edged down to 7% in August and analysts surveyed by Reuters forecast data on Wednesday will show a further dip to 6.8% in September, still far above the central bank's 2% target.
RECESSION WORRIES MOUNT
While business sentiment stayed positive in the third quarter survey, there are early signs that pressures on prices and wages are easing. Labor and supply chain bottlenecks restraining business capacity, may have peaked.
Firms linked to housing activity expect higher interest rates to hurt their sales, while others now see slower - though still healthy - sales growth, the survey found.
"While many firms anticipate a recession, those not linked to housing activity and other household consumption do not expect it to have a large impact on demand for their products and services," the survey said.
Governor Tiff Macklem said last week that the central bank still believed a recession could be avoided, though he warned the path to a "soft landing" was narrowing. Analysts are more sceptical.
"I don't believe in a soft landing in the current situation," said Robert Asselin, a senior policy analyst at the Business Council of Canada. "The bank is very aggressive with hiking rates... I think it will continue and the conclusion of that has to be that there will be significant economic damage."
The Canadian dollar was trading 1.2% higher at 1.3710 to the U.S. currency, or 72.94 U.S. cents.