Strong business sentiment supports January rate hike

Business sentiment remains positive, reveals the Bank of Canada’s business outlook survey (BOS), and that supports the potential for a rate hike next week.

Read: Rates to rise starting next week: big five banks

The BOS indicator, which summarizes the main survey responses, has almost returned to its summer peak.

“In particular, strong expected input price growth and investment intentions pushed up the indicator,” says the report. “Responses to nearly all the BOS survey questions are holding above their historical averages and thus contributing positively. The result signals that positive business sentiment is widespread.”

The report says the sales outlook is healthy despite some moderation ahead.

“Following broad-based strength in past sales, many firms expect stable sales growth or a return to a more sustainable pace, particularly in the goods sector and in demand from domestic customers,” says the report.

Derek Holt, vice-president and head of capital markets economics at Scotiabank*, puts that sales outlook in perspective: “Recall that Canada practically grew like an emerging market over the prior twelve months,” he says in a separate report. “It’s natural for businesses to indicate cooler sales growth expectations, but it’s still a positive reading that fits a story of cooler growth.”

Read: Equity returns, rate hikes and risks: experts weigh in

According to the BOS, firms plan to expand operations to meet sustained demand, evident in a rebound of investment and hiring intentions since the fall survey.

Says Holt: “The percentage of firms saying they plan on hiring more over the next twelve months increased to the second-highest reading of the past two years. That buttressed what we are seeing in the job creation figures.”

Capacity pressures and labour shortages picked up, says the BOS, with shortages most evident in information technology, tourism and hospitality, and construction and real estate—all areas of strong demand. (Survey results suggest economic slack is now largely limited to energy-producing regions.)

In fact, the share of firms indicating more intense labour shortages than a year ago is running at the highest since early 2007.

“That runs contrary to Governor Poloz’s prior assertions that slack remains in labour markets, though it’s conceivable he views this as a transitory first-round effect, with the second-round effect possibly taking the form of higher wages pulling more potential workers off the sidelines,” says Holt.

Inflation expectations are largely unchanged from the last survey, with most firms (56%) expecting inflation to hover in the 1% to 2% range. However, this is down from 70% in Q2.

“Businesses are shifting away from their bias that inflation will remain in the lower half of the BoC’s target range,” says Holt. “Indeed, the share are saying they expect inflation in the 2-3% range held high.”

Minimum wage increases are part of the reason. “A number of the firms anticipating somewhat higher inflation cited rising labour costs, particularly minimum wage increases,” says the BOS.

Douglas Porter, chief economist at BMO, notes in another report that the share of firms expecting labour costs to rise is at its highest level in almost seven years, with B.C. firms reporting widespread pressures and those in central Canada expecting minimum wage hikes to be the principal driver of labour costs.

Recent interest rate increases aren’t materially affecting operations, with most firms reporting no change in credit conditions.

No NAFTA worries

Though businesses indicate NAFTA is a concern, that’s offset by other positive developments.

“While respondents are increasingly concerned about the renegotiation of the North American Free Trade Agreement and rising protectionism more generally, most see healthy U.S. growth and the low Canadian dollar benefiting their sales over the next 12 months,” says the BOS.

It’s a sentiment Holt’s happy to hear.

“Canadian businesses’ investment and hiring plans are not indicating great concern toward NAFTA negotiations, and that is a big sigh of relief at this point,” he says in his report. “This reinforces Poloz’s bias to deal with NAFTA risks if and when they arise, but to treat it as business as usual in the meantime and conduct monetary policy accordingly.”

In Porter’s view, a hike is imminent. “It appears highly likely that a data-dependent Bank will set aside its recent caution, and hike rates 25 bps at next week’s meeting,” he says.

The survey includes sentiment from 100 firms and was conducted between Nov. 14 an Dec. 8, 2017.

For more details, read the full BOS survey, and the reports from Scotiabank and BMO.

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Correction: *A previous version of this article misidentified Derek Holt’s employer. Holt is vice-president and head of capital markets economics at Scotiabank. We regret the error. Return to the corrected sentence.