Sunny outlook may be sign Poloz has been awaiting
There’s new evidence that Canadian executives have stopped reading the news.
For most of the third quarter, the media filled pages and jammed airwaves with blow-by-blow coverage of the fight to save the North American Free Trade Agreement. The NAFTA talks were described as existential, rather than just consequential. Failure would be ruinous, and failure looked likely right up until the 11th hour.
Who in their right mind would make a significant business decision with such a dark cloud obscuring the horizon?
A large number of Canadian executives, as it turns out. The Bank of Canada reported Monday that one of its favourite indicators of business investment rebounded to a “high level” over the summer, as a majority of executives in the quarterly Business Outlook Survey said they would be spending more money to boost production over the next 12 months.
The central bank noted that the latest survey was completed before Sept. 30, when Prime Minister Justin Trudeau and U.S. President Donald Trump agreed on the terms of a new North American trading arrangement just before midnight. That suggests Canadian business confidence was strong despite weeks of negative headlines about the future of Canada’s preferential access to the U.S. market. If there were doubts about whether the central bank would raise interest rates later this month, there can be none now.
“The largely positive results likely understate the current enthusiasm of Canadian firms,” Krishen Rangasamy, an economist at National Bank Financial, said in a note. “All in all, the Bank of Canada would be justified by the data to step up monetary policy normalization.”
Usually, the central bank only wants to know whether spending will increase or decrease over the next 12 months. (In the third quarter, 51 per cent said they would increase investment, and 19 per cent said they planned to spend less, the second-widest positive spread in records that go back a decade.)
But lately, the survey has included questions about what is driving decisions to either invest more or to cut back. The central bank found that a significant number of companies said they were investing to keep up with demand and to reorient for the future. That’s significant because earlier surveys indicated that most business spending related to upkeep. So the investment Canadian companies were considering over the summer was of the type that boosts the country’s economic potential.
“Many firms reported increasing investment spending in response to anticipated strength in demand and capacity pressures,” the Bank of Canada said. “Indeed, a majority of businesses — more than in recent surveys — are investing to expand production or improve efficiency, while fewer firms are limiting their upcoming investment spending to maintenance of existing capital.”
This could be the shift in business psychology for which Stephen Poloz, the Bank of Canada governor, has been waiting.
Rather than panic at the first sight of inflation, he kept interest rates low. Poloz argued that by letting the economy run a little hot, companies could be coaxed to expand; that expansion, he said, would increase the economy’s capacity to produce inflation-free growth. The central bank will raise interest rates on Oct. 24 because indicators of economic growth have been solid and there still is a wide gap between the current benchmark rate (1.5 per cent) and the rate at which monetary policy is neither stoking nor choking growth (2.5 per cent to 3.5 per cent). But evidence of business expansion will give Poloz and his deputies another reason to take that walk slowly.
Aubrey Basdeo, head of Canadian fixed income at BlackRock in Toronto, sees a quarter-point increase in October and then again in January before another lengthy pause.
“The economy is at cruising altitude,” Basdeo said in an interview on Oct. 12.
If the country ’s ruling politicians like that trajectory, they might want to give companies even more reasons to invest.
The results of the autumn Business Outlook Survey show that the Opposition’s suggestion that investment has evaporated is grossly exaggerated. But there is a hint that Trudeau and the premiers could use their powers to stoke animal spirits, as 18 per cent of firms said “regulations and taxes” were impediments to investing in Canada. “Firms typically referred to domestic regulations, often related to environmental approvals (including those for future pipeline capacity), as well as lengthy processes for obtaining project approval,” the central bank’s survey said.
The number of companies protesting Canadian taxes and regulations is relatively small; still, it’s large enough to be taken seriously. By persuading that group to invest at home rather than abroad, the Bank of Canada might find that interest rates could be left relatively low for a little longer.
“Nothing really changed with NAFTA,” said Basdeo. “It’s all about competitiveness now.”