Expectations the Bank of Canada (BoC) will raise its key interest rate target next month were bolstered Friday after stronger-than-expected economic growth in April and a report suggesting widespread business optimism.
The BoC’s outlook survey indicator climbed to its highest level since the second quarter of 2011 as responses to most survey questions were above their historical averages.
However, the central bank noted almost all of the interviews with firms for the business survey were done before the U.S. announcement on tariffs on steel and aluminum imports from Canada.
Escalating trade tensions between Canada and the U.S., including the threats of additional tariffs on the auto sector, have raised concerns for the economy.
Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets, said the solid increase in the outlook survey indicator shows the economy was in good shape heading into the tariff strife.
“With governor Poloz saying that the bank will not be shaping policy based on headlines, and the economic backdrop in generally good shape, there’s a solid case for a July rate hike,” Reitzes wrote in a report. “Even so, we’ll be waiting to see if Trump reacts to Canada’s retaliatory tariffs, as a further escalation could drastically change policy dynamics.”
The BoC survey came as Statistics Canada reported Friday real gross domestic product (GDP) edged up by 0.1% in April over the previous month, topping the expectations of economists for no change for the month.
Gains in the manufacturing and utilities sectors more than offset declines in construction and in mining, quarrying, and oil and gas extraction to help the output of goods-producing industries rise by 0.2%.
Activity in the manufacturing sector rose 0.8% in April as the output of both durable and non-durable manufacturing grew.
Services-producing industries were essentially unchanged overall for the month.
“With cold weather in much of the country, one-off factors hitting the mining and oil and gas industries, and some soft advance indicators, it was a welcome surprise to see a modest expansion of the Canadian economy in April,” Toronto-Dominion Bank senior economist Brian DePratto wrote in a report.
Both the business outlook survey and the reading on GDP will be scrutinized by the central bank ahead of its interest rate decision next month.
The BoC kept its key interest rate target on hold at its last rate announcement, but the central bank’s accompanying statement was interpreted by many economists as suggesting that rates could head higher later this year.
However, the Trump administration announced tariffs on steel and aluminium imports a day after the last rate announcement and has since threatened additional tariffs on other goods including automobiles. Canada has responded with its own plans for tariffs on U.S. steel and aluminum imports as well as duties on a wide range of other goods.
BoC governor Stephen Poloz said earlier this week the escalating cross-border trade fight and new mortgage rules will “figure prominently” in the central bank’s upcoming interest-rate decision.
The governor added the central bank will continue to focus on economic data it can model rather than trying to follow political rhetoric.
The BoC business outlook survey of about 100 firms found the balance of opinion on future sales growth was marginally positive as domestically-oriented firms, including those tied to housing in some regions, expected a moderation in growth.
It noted that firms that were optimistic about their sales prospects often expected to benefit from sustained foreign or domestic demand, improving commodity prices or new products or initiatives to increase market share.
“In particular, firms serving foreign customers reported that orders have improved compared with 12 months ago, and they expect export sales to increase at a greater rate over the next year,” the report said.
However, the survey also said the number of firms that would have significant difficulty meeting an unanticipated increase in demand has increased to levels not seen since before the 2008-09 recession.
“Reports of labour shortages are most prevalent in British Columbia but are also common in Central Canada,” the report said.
The BoC has raised its key interest rate target three times since last summer, moves that have prompted Canada’s big banks to raise their prime lending rates. The central bank’s target for the overnight rate sits at 1.25%.
The business outlook survey was conducted from May 3 to June 5.