EconoFACTS

October 18, 2021 | 11:38

BoC's BOS & Consumer Survey (2021Q3) — Inflation Worries Front and Centre

Economist

Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal for over a decade. He is responsible for the Canadian macro-economic... (Read more)

Benjamin Reitzes

Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal for over a decade. He is responsible for the Canadian macro-economic... (Read more)

The Bank of Canada's Q3 Business Outlook Survey showed a surprise improvement in sentiment, with the Business Outlook Indicator rising 0.77 pts to a record-high 4.73. The survey was taken from mid-August to mid-September, as the reopenings proceeded. And, with heightened inflation concerns abound, the inflation indicators were generally firmer, amid clear signs that supply chain disruptions are having a big impact on Canadian businesses.

Some details from the Q3 report:

Unlike in prior Surveys, the report starts with the capacity, labour and inflation questions (usually it's sales first). Capacity pressures hit a record-high with 65% of firms reporting some or significant difficulty meeting an unexpected increase in demand. Notably, a record 26% of firms were in the significant category. The two biggest drivers of the capacity constraints are: "supply chain disruptions and labour shortages". The latter is a concern for 81% of firms who cited constraints, while supply chain issues clocked in at 46%. "Firms now expect supply chain disruptions to continue until the second half of 2022, longer than they previously anticipated."

On the labour front, 36% of firms noted labour shortages, not a record but at the high end of the past decade. The intensity of those shortages ramped up, with record 64% citing increased difficulty in hiring. Meantime, a record 67% of firms are looking to increase hiring. "Plans to increase wage growth are widespread. Firms reported their compensation plans are fuelled by the need to attract and retain workers amid strong labour demand."

Despite wage hikes coming, ongoing supply chain issues, and rising commodity prices, only a net 8% of firms expect input & output price inflation to accelerate in the next 12 months. (Perhaps because prices are already rising at a pretty high pace?)

On inflation expectations, nearly half (45%) see above 3% inflation over the next year, while 42% are in the 2-to-3% category and a mere 10% are in the 1-to-2% camp. Those in the 3+% segment most often cited supply chain disruptions, fiscal/monetary stimulus and food and energy prices as the key drivers. The BoC added a special question, which might be among the most important in the entire BOS: "In response to a special topic question, most firms anticipating inflation above 2 percent and about half of those with expectations above 3 percent said that the drivers of higher inflation are temporary."

On to the rest of the details...Future sales growth fell 38 ppts to 9%, from the prior quarter's 47%. As the reopenings proceed, some pullback in expectations was fully expected, as prior quarters' levels were unsustainable. Hard-to-distance services sectors are the most upbeat about growth prospect, as the reopenings proceed, while other firms have pared their expectations somewhat. Notably, indicators of future sales (i.e. order books, etc.) were down a lesser 19 ppts to a still-strong 54%. Despite the improvement in service-sector sentiment, uncertainty surrounding Delta has many firms expecting a full recording will take over a year.

Investment intentions jumped 10 ppts to 46%, a record high, as firms are looking to capitalize on strong demand, both domestic and foreign. Capacity pressures and labour shortages are playing a role here as well, while there's still some catch up from investments delayed due to the pandemic. Longer-term investment expectations are solid as well, with "more than half of firms indicated that capital expenditures over the next two to three years will be higher than what they typically were before the pandemic."

Lastly, the balance of opinion on credit conditions tightened a touch but remains relatively loose.

The Survey of Consumer Expectations showed that sentiment remains strong. Spending plans have perked up, but some caution remains due to Delta. There's strong confidence in the labour market, with people more willing to change jobs, though Canadians are not expecting wage gains. Finally, "Canadians think inflation will be higher in the near term due to supply disruptions, but they do not expect this situation to last. Inflation expectations remain well anchored."

Bottom Line: Inflation was in the spotlight heading into this report, and the details were generally firmer. The answers to the standard questions reflect heightened inflation concerns, with expectations moving higher and wage costs expected to rise amid supply chain issues, labour market tightness and commodity prices climbing. Capacity pressures hit a record high. However, firms and consumers don't expect these inflation pressures to last, consistent with the Bank of Canada's transitory inflation narrative. Meantime, back on the activity front, businesses expect the recovery to continue, while households are still itching to spend. We'll have to see if more persistent inflation changes that outlook. There should be little doubt that the BoC will taper again at its October 27th meeting. The bigger question is when rate hikes come and whether market pricing of aggressive hikes in 2022 has gone overboard.

Table 1 - Bank of Canada — Business Outlook Survey

(balance of opinion : greater minus lesser : %)

Source: BMO Economics, Haver Analytics, Bank of Canada