The BoC's new Business Outlook survey suggests that the economy ended 2014 on a moderately firm footing. However, while growth of economic activity has accelerated compared with October, expectations have been downgraded significantly.
The balance of firms indicating a pick-up in annual demand growth was 21 percent, up 7 percentage points from last time and its strongest reading since the second quarter of 2012. Nonetheless, firms have become much more cautious about the outlook with a majority of just 8 percent anticipating a faster pace of sales this year following a 35 percent outturn last time.
As a result, investment intentions have been pared back (8 percent after 20 percent) and the net percentage of companies planning to increase spending on machinery and equipment declined to its lowest level since the third quarter of 2013. Similarly, hiring plans (31 percent after 44 percent) are no longer so bullish.
Meantime, signs of capacity constraints were little changed with a majority of 7 percent, down just 1 percentage point from October, envisaging major difficulties in meeting an unforeseen increase in demand. Labour shortages (22 percent) were up 4 percentage points but only returned to their second quarter level.
Not surprisingly inflationary expectations have been slashed and a small majority of 3 percent expect input prices to rise at a slower rate this year than in 2014 compared with a net 9 percent seeing an acceleration in the previous quarter. Anticipated output price inflation (minus 5 percent after 8 percent) has been similarly cut drastically. In turn, CPI inflation is now seen by 68 percent of respondents falling in a 1-2 percent range over the next two years, up from 59 percent last time.
Lastly, a net 3 percent regard credit conditions as having eased further since last quarter when the comparable reading was minus 11 percent.
In sum there is plenty of ammunition here for the BoC to justify retaining a clearly dovish stance at next week's policy-setting meeting.
The survey's purpose is to gather the perspectives of these businesses on topics of interest to the Bank of Canada (such as demand and capacity pressures) and their forward-looking views on economic activity. The report is based on a summary of interviews conducted by the Bank's regional offices with the senior management of about 100 firms, selected in accordance with the composition of Canada's gross domestic product.
The outlook survey is used to evaluate economic conditions prior to four Board meetings a year where the BoC sets interest rate policy. Although monetary policy is announced eight times a year, these reports are available only on a quarterly basis. Market participants speculate for weeks in advance about the possibility of an interest rate change that could be announced upon the end of these meetings. If the outcome is different from expectations, the impact on the markets can be dramatic and far-reaching.
If the survey portrays an overheating economy or inflationary pressures, the Bank of Canada may be more inclined to raise interest rates in order to moderate the economic pace. Conversely, if the survey portrays economic difficulties or recessionary conditions, the Bank of Canada may see the need to lower interest rates in order to stimulate activity.
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