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Bank of Canada wary of business investment surge that seems too good to be true

Bank of Canada wary of business investment surge that seems too good to be true

Earlier this week, New Look Vision Group Inc., Canada’s biggest seller of eyeglasses, bought a Miami-based outfit called Coco Lunette Holding LLC, which runs a dozen stores in swanky Florida locations such as Boca Raton and Naples.

Not only was the acquisition the first in the United States for Montreal-based New Look, it was the first foray into the American eyewear market by a Canadian company, ever, according to the Dec. 2 announcement.

“We are always on the lookout for great opportunities,” chief executive Antoine Amiel said in an interview.

Headline economic data over the past couple of years have tended to obscure such confidence.

Hiring was off the charts, but measures of investment were lacklustre. On a quarter-to-quarter basis, business spending on machinery and equipment dropped in three of four quarters through the end of June, according to Statistics Canada data.

The decline was discouraging, but it made sense. The trade wars were choking exports, so it stood to reason that companies would retrench until the uncertainty passed. The Bank of Canada gave serious consideration to cutting interest rates in October in part because its forecasts showed that business investment was sure to drop again in the third quarter.

But that’s not what happened.

StatCan reported last week that business investment surged at an annual rate of 9.5 per cent in the third quarter, reversing a seven-per-cent drop in the second quarter. And revisions showed that investment in non-residential structures and machinery and equipment had actually accelerated to an annual rate of 18 per cent at the start of the year, suggesting companies took advantage of lower taxes on investment that the Trudeau government implemented at the end of 2018.

And just like that, business confidence argues for leaving interest rates unchanged, not cutting them. With inflation at the central bank’s target, there’s no reason to take out insurance against the trade wars if companies are finding ways to push forward on their own.

“One thing that surprised us was business investment,” Timothy Lane, a deputy governor at the Bank of Canada, said in a speech in Ottawa on Dec. 5, explaining this week’s decision to leave interest rates unchanged. “We were expecting investment to decline in the second half of the year, but instead we have seen solid growth.”

Lane was presenting the Economic Progress Report, which the central bank uses to refresh its assessment of the economy between the release of its quarterly outlooks. For the most part, the world has unfolded as the Bank of Canada thought it would two months ago. Gross domestic product expanded at an annual rate of 1.3 per cent in the third quarter, just as policy makers predicted it would. That was a sharp slowdown from the second quarter, but Lane said recent data support their view that the “slowdown will be temporary.”

The central bank’s cautiously optimistic tone this week surprised some on Bay Street. As long as the trade wars rage, there will be a constant threat that Canada could be knocked off course.

“In a risk-filled outlook, with any signs of economic deterioration, it may yet choose to err on the side of supporting growth,” said James Marple, an economist at Toronto-Dominion Bank.

Uncertainty about trade was the main reason the Bank of Canada assumed business investment would remain weak. Policy makers still might have been correct. Imports of industrial machinery, a proxy for investment, declined for a second consecutive month in October, according to monthly trade data that StatCan published on Dec. 5.

And there was a certain wariness around the central bank’s handling of the investment numbers. Lane said officials will be using the weeks ahead to get a better feel for what could be going on. The stronger spending bodes well for economic growth, which could put upward pressure on inflation. Or, the economy may have added capacity that would allow for faster growth without stoking price increases.

“The bank will need to assess the extent to which this strength is likely to be maintained as well as implications for both economic growth and potential output,” Lane said.

If the Bank of Canada isn’t entirely confident that investment is as strong as the numbers suggest, neither is Michael Greenberg, a vice president and portfolio manager at Franklin Templeton.

He observed in a presentation in Montreal this week that Canadian profit margins are compressed and earnings per share have been roughly flat for a year. “It’s not the end of the world, but it’s not vigorous either,” he said of the economy. “It’s not an environment where companies want to spend a lot of money.”

Getting a read on the mood of business will be complicated by the fact that data don’t always reflect actual sentiment. There are many more variables at play than tariffs.

Amiel, the New Look chief executive, led his company to record sales last year. He’s got money to expand, and said he is held back by his desire to work only with like-minded partners, not the trade wars or the economic outlook.

He toyed with buying the high-tech gear and software he’d need to use facial recognition to design custom glasses, but decided to invest in a San Francisco-based startup instead. If that company’s tech pans out, then there is a possibility New Look would start making individual frames in Montreal rather then importing in bulk from Asia.

The trade wars, Brexit, and other sources of uncertainty are present, but haven’t kept New Look from passing on an opportunity, Amiel said. “I can’t say that over the past 18 months there was a particular file we decided to let go for that reason,” he said.