The central bank released its fourth-quarter business outlook and consumer expectations surveys Monday, revealing most businesses and consumers expect a recession in the next 12 months.
As business confidence weakens, more firms are reporting they're concerned about demand and credit. Meanwhile, they say cost pressures, labour shortages and supply chain issues are easing.
On the consumer side, Canadians facing high inflation and rising interest rates say they're cutting back on spending as they spend a larger share of their budgets on necessities.
Nearly nine in 10 say they have cut spending on travel, accommodation, food service and recreation.
More than seven in 10 say they're cutting on clothing and footwear, while nearly six in 10 consumers are pulling back on groceries.
The surveys "suggest that interest rate increases are working as expected in slowing spending," CIBC's executive director of economics Karyne Charbonneau wrote in a note to clients.
Since March, the Bank of Canada has aggressively raised interest rates seven consecutive times in response to decades-high inflation. Its key interest rates is currently 4.25 per cent, the highest it's been since 2008.
Though inflation has eased in recent months, it's still well above the Bank of Canada's two per cent target.
The central bank is expected to keep interest rates elevated for some time to further take the steam out of the economy and inflation.
With the economic outlook somewhat cloudy, some businesses expect sales to slow and are pulling back on their investment plans.
According to the business outlook survey, two-thirds of firms expect a recession in the next 12 months.
However, despite the expected slowdown, half of businesses said they're planning to add employees or to fill vacant positions in that same time period.
Meanwhile, 72 per cent of consumers expect a recession in the months ahead.
That's in line with what many economists are forecasting for the Canadian economy, citing a strong labour market as a potential buffer during a downturn.
However, although the labour market has remained relatively strong, Canadian workers have seen their real wages fall amid high inflation. According to the consumer expectations survey, most workers do not expect their earning to catch up with inflation.
The surveys also show both businesses and consumers expect inflation to remain elevated in the short-term but expect it to ease, sitting closer to the central bank's target of two per cent in five years.
More than a quarter of consumers expect to see deflation in five years with many believing prices will decrease as the economy recovers from supply-side shocks.
RBC assistant chief economist Nathan Janzen said it was "surprising" to see the number of people expecting prices to fall in the long-term.
"I don't know we're so optimistic that that's true. It's tougher for prices to fall than it is for them to go up," he said.
The new data comes ahead of the Bank of Canada's next interest rate decision, set for Jan. 25.
Though the Bank of Canada signalled last month a willingness to press pause on the rate hiking cycle, many commercial banks, including RBC, expect the central bank to raise its key rate by a quarter of a percentage point.
"I don't think that's that's changed with this data," Janzen said.
Statistics Canada will release its December consumer price index report Tuesday, which will also inform the central bank's decision, he added.