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The Bank of Canada’s summer 2008 Business Outlook Survey showed a deterioration in the outlook for inflation on a number of fronts. Even more surprising, there was not a similar deterioration in the outlook for growth, with some of the measures even managing to retrace some of the weakness recorded in the spring. The summer survey was conducted between May 20 and June 13, 2008.

The survey results are reported as diffusion measures, or balance of opinion, that essentially take positive responses less negative responses to various survey questions. A key question on inflation asks respondents where they expect CPI inflation to average during the next two years. The summer survey showed a jump to 36% of those who expected inflation to average more than 3% during the next two years. This is up from the 17% recorded in the spring and is the highest percentage ever recorded in the survey.

The balance of opinion for the outlook for input and output prices showed a similar deterioration. For example, the balance of opinion for input prices deteriorated to 38 in the summer survey from 26 in the spring, while the measure for output prices rose to 20 from 10 during the same period.

The deterioration largely reflected the continuing strong gains in energy prices. However, it was also consistent with a re-emergence of concerns about capacity constraints. Those companies facing some or significant difficulties meeting an unexpected increase in demand rose 49% from 44% in the spring. Most of the pressure emanated from the western provinces, the Prairie provinces in particular. Similarly those firms encountering shortages of labour rose to 40% in the summer survey from 30% last quarter. The Bank of Canada indicated that the labour shortages were once again concentrated in western Canada, although mostly in British Columbia.

The balance of opinion on the outlook for future sales improved slightly to a reading of 4 and thus returned to positive territory after recording a -2 in the spring. However, the Bank of Canada characterized the results as little changed and remaining relatively close to zero.

One area that showed a marked improvement was the outlook for M&E investment, which soared to a net reading of 24 after falling to 1 in the spring. The low level of the balance of opinion in earlier quarters had been surprising. With commodity prices remaining at historically high levels, there seemed to be a reason for producers to add to capacity, which is more consistent with the strong reading registered in the summer survey.

The balance of opinion for past sales deteriorated slightly to a reading of 7 from 9 in the spring. The balance of opinion for employment remained unchanged, although it is already at a relatively high reading of 33, with 44% of respondents in the summer survey expecting to increase employment compared to 11% who expect to reduce hiring.

The continuing deterioration in the outlook for inflation is consistent with the recent shift in tone at the Bank of Canada with increased concern being raised about the inflation outlook. This does imply a rising probability that interest rates could be raised near-term, particularly with indications of some improvement in the near-term growth outlook. However, the central bank will likely also have to take into consideration the recent deterioration in financial markets that are indicative of the cost of capital once again starting to rise with attendant downward implications for growth and capital spending. As a result, we continue to expect the overnight rate will be held steady through the remainder of the year with the neither the downside risks to growth nor the upside risks to inflation becoming sufficiently pronounced to prompt any policy response.

RBC Financial Group
http://www.rbc.com

The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.