Because it takes several quarters for interest-rate changes to work their magic on an economy, monetary policy is by its nature a forward-looking business. So the Bank of Canada probably won’t do too many cartwheels over Tuesday’s impressive gross domestic product report for May as it considers further rate increases.
It’s a good bet the central bank is putting more stock in the Business Outlook Survey (BOS), its own quarterly poll of business sentiment. The BOS is, after all, designed to look down the road, as it asks business owners and senior managers about their sales expectations and their spending and hiring intentions over the next 12 months. The most recent BOS – conducted from May 3 to June 5, roughly the same period reflected in the May GDP report and released at the end of June – indicated that overall business optimism is near record levels.
So the combination of the GDP and BOS data tell us that the strong growth is about to be carried forward, right? Well, maybe not. A recent report from Canadian Imperial Bank of Commerce says that, as an economic indicator, the BOS is really more a reflection of the economic present than a crystal ball into the future.
CIBC’s historical analysis found that the BOS indicator – the Bank of Canada’s summary reading of the overall survey results – is fairly highly correlated with GDP growth in the quarter in which the survey was taken. But in the four subsequent quarters – the period that the survey’s forward-looking questions are supposed to reflect – the BOS indicator actually has a small (but still statistically significant) negative correlation with GDP.
In other words, economic performance over the 12 months following any given Business Outlook Survey is actually more likely to be the opposite of the BOS’s signal than be consistent with it.
We now know, from Tuesday’s GDP report, that the period covered by this BOS roughly coincides with what was the strongest month of economic growth in nearly two years, a 0.5-per-cent month-over-month surge that was spread broadly across most sectors of the economy.
But based on CIBC’s analysis, the BOS may simply be telling us the same thing the May GDP report did.
Basically, the BOS has been pretty good at illustrating that when business is good, business leaders are optimistic, and when business is bad, their mood darkens. While that might seem obvious, it’s also not that helpful – if what you’re looking for is a reliable predictor of future behaviour.
So do a backward-looking GDP report and, at best, a sideways-looking Business Outlook Survey, really tell the Bank of Canada much of anything?
Absolutely. The BOS delivered an important message that businesses are running very short on available capacity and labour. The GDP report fleshed out that story, suggesting that the economy probably grew at about 3 per cent annualized in the second quarter – well above the pace that the bank believes capacity is growing. That means the shortages that businesses reported in the survey got even more acute during the quarter.
An economy running at full capacity, and growing faster than new capacity is added, is one that is destined for rising inflationary pressures – and inflation is the ultimate driver of Bank of Canada rate policy. The two indicators, then, give the central bank a green light for further rate increases, even if their predictive abilities are dubious.
Still, the strong second-quarter GDP could well prove to be an outlier. If growth in the quarter is, in fact, in the neighbourhood of 3 per cent annualized, that’s nearly double the average of the prior three quarters. The Bank of Canada itself forecasts that growth will revert to something closer to that previous trend in the third quarter.
Meanwhile, businesses have good reason to have reined in confidence since the previous BOS was taken. The U.S. tariffs on Canadian steel and aluminum, threats to slap tariffs on the auto sector and the general acceleration of U.S. protectionist policies over the summer have elevated business uncertainty about competitiveness and access to a critical market.
If that uncertainty translates into a slowdown in hiring, investment and capacity expansion, it will speak volumes about how much the economy can grow in the months ahead. That, in turn, will determine how aggressively the Bank of Canada will raise rates. Unfortunately, the Business Outlook Survey might prove more short-sighted than the central bank would like in providing answers to those key questions.
David Parkinson