BoC: Businesses Remain Optimistic about the Future

Fundamental analysis of Forex market

Canadian firms were upbeat over the third quarter of the year, according to the Bank of Canada’s quarterly Business Outlook Survey (BOS). The Bank’s “BOS Indicator” remained elevated despite falling back a touch to 2.8 (from 3.1).

It’s important to note that the survey was conducted between August 24th and September 19th, just before the breakthrough that resulted in the new USMCA free trade deal.

The balance of opinion around future sales rebounded to 15% (from 6% in 18Q2), as firms anticipate strong U.S. growth over the next year to help boost export orders. In contrast, ‘indicators of future sales’, which captures order books, advanced bookings, and similar metrics, eased to 40% after rising for two consecutive quarters.

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After falling in the previous two quarters, investment intentions saw the balance of opinion rising to 33% – the highest reading since 17Q1. The details of the report show that capacity constraints are helping driving investment intentions higher. Moreover, firms also appear to be on a drive to improve productive efficiency, with fewer firms intending to spend just to maintain their current capital base. Drivers and impediments to business investment were fleshed out in Box 1 of the report. Domestic and foreign demand were among the key drivers of investment, while uncertainty and regulation and taxes were cited as key impediments to investment.

The drive to expand capacity is also leading firms to increase hiring over the next 12 months, but this may prove challenging as labour shortages appear to have become more intense and widespread. At 50%, the balance of firms reporting more intense labour shortages has risen to its highest level since 2006Q3.

Rising capacity pressures, more intense labour shortages, steel and aluminum tariffs, along with higher commodity prices are feeding through into expectations that input prices are likely to rise at a faster pace in the year ahead. On balance, firms expect to raise output prices, with about three-fifths of firms expecting inflation to transpire in the 2% to 3% range. However, competitiveness concerns continue to remain a source of negative price pressures.

Senior Loan Officer Survey

The Senior Loan Officer Survey (SLOS), was also released this morning and continued to indicate an easing of lending conditions for businesses. This marked a fourth consecutive quarter of easier lending terms for businesses amid increased competition among lenders for corporate borrowers. Lending conditions for small business and commercial borrowers remained unchanged, while demand for credit strengthened broadly from all business borrowers.

On the household side, lending conditions have remained little changed from the prior quarter. Mortgage lending conditions, particularly the price component, continued to ease as lenders competed for reduced pool of borrowers owing to B-20 rules. Demand for high-ratio mortgages has remained unchanged, but increased for both low-ratio mortgages and home equity lines of credit. Lending conditions for non-mortgage credit have tightened slightly relative to the prior quarter, while demand has remained relatively unchanged with softer demand for auto loans offsetting increased demand for other types of consumer credit.

Key Implications

Canadian firms remain bullish on the future. The boost in investment intentions corresponds to elevated capacity pressures and should help alleviate concerns that firms won’t be able to meet the anticipated increase in domestic and foreign sales. In addition, labour shortages may be a sign that wage pressures should continue to build, adding to the basket of inflationary pressures down the road.

On the lending side, the slowdown in Canadian housing market activity has weighed on mortgage growth. Mortgage credit has decelerated significantly in the aftermath of the B-20 guidelines, falling to 3.7% y/y in July, down from a 6% y/y pace at the same point in the previous year. Although activity has rebounded from a slump in the first half of the year, the Canadian housing market is expected to continue to face challenges in this rising interest rate environment.

A solid BOS, together with stronger than expected growth in the third quarter, should provide the Bank of Canada with more than enough conviction to move rates higher by another 25bps next Wednesday. It also raises the question of the timing of the next rate hike now that the USMCA has alleviated some of the trade-related uncertainty that was exerting a headwind on its growth outlook. Assuming economic data continuing to confirm the Bank of Canada’s outlook for growth and inflation, we expect the next hike likely to come in early 2019.