The Bank of Canada was reinforced Monday by the vast majority of Canadian businesses surveyed in believing that inflation, despite recent upsurges, is pretty well going to stand still over the next year.
Inflation expectations are not just well anchored in the survey on which the BOC places considerable importance, but fully 64% of surveyed businesses expect inflation to run between 1% and 2% over the next two years, either seriously below the Bank’s desired 2% target or just at it. Another 30% expect inflation to run within the BOC’s target range of 1%-3%. That’s 94% who see no big inflationary pressures ahead.
Inflation at an annual rate rose sharply from months of seriously low levels that had given rise to some concern about disinflation, to the 2% target in April and to 2.3% in May. That gave rise to criticism that the BOC was falling behind the realities of the times, should recognize that stronger inflation was here to stay, and should abandon its neutral bias that the next policy interest changes off the present 1.0% rate could be either up or down.
The Bank has argued that inflation upticks were transitory and that the tepid growth of the domestic economy combined with great uncertainty about United States demand for Canada’s exports called for continued caution. The Business Outlook Survey (BOS), though taken May 20-June 12, before the latest CPI rise to 2.3%, tends to reinforce the BOC’s stance on inflation and on a rather tepid outlook for growth in general.
Certainly, there have been brighter reports among the grey ones, such as Monday’s report by Statistics Canada that building permits rose in May by 13.8%, the largest monthly increase since July last year. Residential building permits, in particular, rose 9.5% in May for a third straight monthly increase.
Even here, it is notable that although the month’s data was strong, residential permits were down 9.0% from May of last year and non-residential building permits were down 2.3%.
Canada’s export trade picked up as well in May, to a deficit of -C$152 million from -C$961 million the month before, but that still is a deficit in a very long string of them over recent years. And as the Bank itself says, in the United States, which takes over 70% of Canada’s exports, the growth indicators are mixed and the outlook uncertain.
It is exports and domestic business investment that the Bank has long said it is counting on – counting, and counting, and counting, with not much positive happening – as the coming chief drivers of economic growth. Businesses are not so sure about either.
The Survey showed that expectations for U.S. economic growth got stronger and that “orders from domestic and international customers show improvement from a year ago.” But not a lot of improvement. Two things are important here. First, the balance of opinion on intentions to invest in machinery and equipment (M&E), in order to further exports, has 41% expecting to do more while 42% plan no change and 17% expect to spend less in this year. Second, those who plan to spend more on M&E are going to do that on upgrading or replacing existing machinery, not to expand. Firms just want to improve efficiency of what they have “over the near term as they await more widespread indications of improving demand.”
Economic growth remains measly. In April, GDP growth was all of 0.1%, the same as in March. The BOC said in its April Monetary Policy report that it expected real GDP growth to average about 2.5% both in 2014 and 2015, and then to fall to about 2% in 2016. On present data, growth is going to have to go some in the second half to reach anything near 2.5% for this year.
The Bank in April expected core inflation “to stay well below 2 per cent this year due to the effects of economic slack and heightened retail competition, and these effects will persist until early 2016. Total CPI inflation is forecast to be closer to 2 per cent over the coming quarters and remain close to target thereafter.” So, if inflation just holds fairly steady hereafter as businesses expect, there may be little reason, given that and the sluggish economy and uncertain outlook about United States’ demand, to change its tone and stance in the July 16 report.
Analysts are muting their criticism that the BOC was out of touch with inflation realities. Several have lately seen, in the Canadian indicators and the choppy ones in the United States, that the Bank could well stand by its position of the recent past.
Among them, economist Leslie Preston at TD Economics wrote to clients Monday that “the BOS provides support that inflation expectations are little changed, and (that) there is little evidence that a further acceleration is coming down the pipe.”
“The BOS would suggest that despite the recent increase in inflation off a very low level, further upward pressures are likely to remain rather muted over the coming months as competitive pressures limit the ability of firms to pass in price increases.”
At CIBC, Avery Shenfeld, chief economist, said that “a softer set of readings (from the BOS) will be seen as providing some support for maintaining its dovish stance.” In the whole report, “the one encouraging note is an increase in the balance of opinion on Machinery and equipment outlays, one of the areas where the Bank is looking for momentum to supplant housing and consumption.”
Paul Ferley, assistant chief economist at RBC, saw the overall picture as suggesting “little urgency to alter policy.” The Bank would have to return to a tightening mode eventually , but upon “confirmation of a sustained strengthening in economic growth.” Such strengthening was not seen as being “sufficiently evident until the second quarter of 2015.”