Bank of Canada Surveys Portray Weak Credit Conditions, Flagging Business Activity

The Bank of Canada released both its Business Outlook Survey for winter 2008-09 and its Senior Loan Officer Survey for the fourth quarter of 2008 this morning. The former survey was conducted during the period from November 14 to December 12, while the latter reflected opinions expressed during the period from December 15 to 19.

The release of theses two documents provides a read on credit conditions from both the borrowers' and the lenders' perspective, respectively. For borrowers, the balance of opinion on credit conditions deteriorated (i.e., tighter, less easy conditions) to record high levels; however, because the survey began in 1997, it has never been conducted during a recession in Canada. Specifically, the balance of opinion on credit rose to +57, almost double the +32 recorded in the autumn survey. The tightening largely came in the form of higher borrowing costs.

From the lenders' perspective, the tightening in credit was the highest recorded since this survey was first compiled in 1999. Lenders indicated that the tightening was in both price and non-price (terms or standards of loans) variables. The tightening that occurred via price largely reflected financial institutions passing along the higher cost of capital that they were encountering within credit markets.

The Business Outlook Survey also covers a number of other aspects of the operation of Canadian firms. In the main, these other indicators are suggesting a deterioration in business activity to record levels. Illustrating the former, the balance of opinion (i.e., positive responses less negative responses) on sales during the past 12 months fell to -25 from –2 in the autumn. The balance of opinion on future sales deteriorated even more to -34 from +3 during the same period.

The measures for investment and future hiring also deteriorated sharply in the most recent quarter. The former sank to -31 from +20. The deterioration in the employment measure was not as marked, although the balance of opinion in the most recent quarter turned negative (-8) for the first time ever.

Weakening economic conditions generally resulted in an easing of measures related to production capacity. This, along with falling commodity prices, sent expectations of inflation lower. For example, nearly three-quarters of respondents expected inflation in the next two years to be below the Bank of Canada's 2% mid-point inflation target.

The two Bank of Canada surveys indicate a marked intensification of credit tightening in the last quarter. This, in turn, weighed on most aspects of economic activity as expressed by the surveyed businesses. These pressures will likely keep the Bank of Canada easing policy both by lower interest rates and by injecting liquidity into the system where needed. With respect to the former, we expect the central bank to lower the overnight rate by 50 basis points to 1.00% coming out of next Tuesday's policy meeting.