Optimism reigns at the Bank of Canada

For decades, Canadian federal governments have been trying to reduce the economy's dependence on the United States as a trading partner -- to absolutely no avail.  The behemoth to our south still accounts for upwards of 70 percent of Canada's goods exports, just as it did when Justin Trudeau's daddy was Prime Minister.

So you'd think that the election of a mindlessly protectionist President would trigger a wave of pessimism among Canadian businesses, right?  Well actually, not right, according to the Bank of Canada's Business Outlook Survey, published on Monday. The Bank finds that after two years of "overall modest activity" (that's one way of putting it), business prospects have improved, reflecting "building domestic demand, a supportive export outlook and an expected recovery in energy-related activity".

These three factors are, in fact, closely related.  The improvement in domestic demand reflects the waning impact of the oil price shock, and the supportive export outlook is largely attributable to the exchange rate weakness which that shock triggered.  Businesses are uncertain about the implications of the election of Donald Trump, but fears of protectionism appear, at least for the moment, to be outweighed by optimism about the potential benefits of the new administration's planned infrastructure spending.  It is all but certain that any infrastructure initiatives launched by Trump will have stringent "Buy America" provisions, so this optimism may well prove unjustified.

The Survey highlights several developments that could, in the fullness of time, push the Bank toward some degree of policy tightening. Capacity pressures are absent for the moment, but there are signs that they could begin to emerge.  There are rising indications of labour shortages in certain regions. Input and output prices are set to rise as the impact of the weakened exchange rate continues to be felt and as firms begin to feel emboldened to rebuild profit margins.  Inflation expectations are edging higher, though they remain at the lower end of the Bank's target range.

None of these developments suggests that the Bank will be raising rates at any time this year, even as the Federal Reserve continues to tighten.  However, the deliberately upbeat tone of this survey, after many quarters of unalloyed gloom, suggests that the Bank is starting to prepare the ground for less accommodative policy, perhaps in the first half of next year -- though of course, all bets will be off if the incoming administration unleashes the chaos that seems to be Donald Trump's stock-in-trade.