The Bank of Canada's Q4 Business Outlook Survey (BOS) showed that corporate sentiment improved slightly in the quarter. This improvement is demonstrated in the increase in the BOS Indicator -- a summary measure of the results of the survey -- to 0.7 from 0.4 in Q3. This continued the recent trend of improving sentiment from its low in January 2019.
The balance of opinion on future sales remained positive, but fell to 11 after two quarters above 20. The balance of opinion is the difference between the percentage of firms expecting an increase and those expecting a decline on a particular survey question.
The balance of opinion on future employment rose to 43, up from 31, and hitting its highest level since 2018 Q1. Additional labour market indicators showed fewer firms reported facing labour shortages, though more firms reported more intense labour shortages.
Over 50% of firms reported that they would face at least some difficulty meeting an unexpected increase in demand, a four quarter high for this indicator of capacity constraints.
The BOS demonstrated that firms remain cautious about capital expenditures with the balance of opinion on the outlook for expenditure on machinery and equipment falling to 11, its lowest reading since 2016 Q2.
As has been the case for three straight Business Outlook Surveys more than 50% of firms expect inflation to remain below 2% over the next two years, even though both total and core inflation are near the 2% inflation target.
We see three interesting features of today's report. First, there are more signs that the economy is operating near potential with emerging capacity constraints as more firms are reporting having at least some difficulty meeting an unexpected increase in demand. As well, labour market conditions remain tight, with elevated labour shortages and firms planning to increase payrolls.
Second, firms remain reluctant to increase capital expenditures, despite emerging capacity constraints. Thus, firms are responding to sales growth by adding workers rather than adding to productive capital. In our view, this points toward an underlying degree of caution that will result in weak productivity growth in coming quarters. In its 4 December policy statement the Bank noted the strong growth in business investment in Q3, and that it would monitor the situation in order to determine if this indicated renewed momentum. Today's BOS points toward a return toward quite moderate business investment in Q4.
Third, the BOS reinforced a regional divide, with business sentiment and economic conditions weaker in the commodity sensitive Prairie region. Evidence of this regional divide is also evident in other data, such as consumer insolvency statistics that demonstrate greater household financial strains in the Prairies.
We view the details of today's report as supportive of our forecast that the Bank of Canada will leave its policy rate unchanged at 1.75% on 22 January.
That said, we think that the results of the BOS largely reflect conditions observed in late Q3 and very early in Q4. As the Bank had completed the interviews by the end of November, the Q4 BOS missed the extended run of weaker than expected data through December. This matters, as the survey would thus largely have seen conducted in the context of data releases relevant to Q3, which showed GDP growth of 1.3%, but with solid business investment.
Meanwhile, the recent run of weak data, has been informative about Q4 economic growth. Notably, weakness in factory sector output and exports highlight that economic indicators that had been consistent with the Bank's narrative about a resilient economy in 2019 H1, faced more difficult conditions toward year end. Data available for Q4 suggest that there are downside risks to our Q4 GDP growth forecast of 1.2%, and the BoC's forecast of 1.3%. Additionally, a Canadian Federation of Independent Businesses survey showed a deterioration in small business confidence in December. These economic conditions were not captured in the BOS released today.
The BOS was conducted between 11 November and 29 November.