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  • KPB & Co Research

With the 2019 federal budget presentation days away, there is one group of people who are largely positive about the upcoming year. A survey of over 60,000 businesses across Ontario including Uber, Enbridge, Rogers, Google, IBM, and Bell shows that on average these businesses are more optimistic about their future, but have more of a wait and see approach towards the province. The more positive sentiment can also be seen in the increase staff at companies in Ontario, which have gone up significantly since 2017 and particularly over the last 5 years. In spite of the more rosy outlook from the perspective businesses, there are indications that economic activity is beginning to slow, analysts expectation at the banks point to a more somber picture. In addition, housing market activity in Canada and US PMI manufacturing index are showing signs of weakness.

Business are more optimistic about their prospects but why ?

Data from the Ontario Chamber of Commerce's (OCC) business confidence survey indicate that businesses in Ontario are on average more optimistic about their prospects for 2019. Of all the companies that responded to the survey 62% are either very confident or somewhat confident in their prospects for 2019. About 27% of respondents were neutral and 12% not confident. The level optimism for 2019 is approximately 7 percentage points higher than that of 2018. Unfortunately, businesses are less optimistic about the prospects for the province, and in our opinion, has adopted a wait and see attitude towards the province in 2019. About 42% of respondents were neutral toward the province's prospects, 27% not confident, and 30% confident about the provinces future. There has also been a marked improvement in the level of pessimism towards the provinces' economic fortunes, with 7% percent more respondents feeling positive and 21% less respondents feeling negative about the province's economic prospects.

In our view, the more positive sentiment towards businesses own economic prospects, and the wait and see approach towards the province's fortunes reflect to a large degree developments in trade negotiations, and the politics of the province. Since 2016, overall sentiment about businesses' own prospects have been declining, and despite the recent positive turn are still below the high established in 2014. The same trend can be seen in the sentiment towards the economic prospects of the province. At the same time there have been growing labour capacity constraints since 2016, which can only happen if there has been an unanticipated increase in demand. Unemployment rates in the province is bouncing from 18 year low, and labour force participation rates are at 42 year lows.

Note: "Lows line" is drag-able

The deterioration in confidence coincides with the November 2016 election of Donald Trump as president of the USA. Understandably, the America first rhetoric promoted by the Trump administration during his campaign and well into his presidency played on the minds of Canadian businesses, as he looked to unravel the North American Free Trade Agreement in favour of deal that tilts the scale more in favour of the USA. A new deal was signed in December 2018 - the United States-Mexico-Canada Agreement- and businesses have become clearer on the direction of trade and more optimistic about their fortunes. On the other hand, Doug Ford took over as premiere of Ontario in June 2018, and expectedly there have been some uncertainty regarding the future of the province as he begins to implement his strategy. As the dust settles and businesses get more clarity on his strategy there could be further improvement in their views on the prospects of the province, assuming Mr Ford does a good Job.

Businesses May Face a Curve Ball in 2019

Notwithstanding the largely positive feedback from businesses there are early warning signs that there could be a slowdown in 2019. First the PMI manufacturing index in the USA is pointing to a slowdown beginning in Q4 of 2018. The USA is Canada's largest trading partner and so a slowdown in the the US is likely to spill over into Canada. Additionally, the gradual increase in interest rates will likely lead to a slowdown in the housing market which account a substantial portion of the GDP of country. Already the Canada Mortgage and Housing Corp is predicting a further slowdown in housing over the next 2 years. According to the CMHC:

Housing starts are forecast to slow down gradually over the 2018 to 2020 forecast horizon, moderating from the 10-year high recorded in 2017 to levels more in line with a moderating economic outlook and demographic conditions. While income, employment and household formation will continue to support new residential construction, these fundamentals will see slower growth. As a result, housing starts will be brought closer to levels broadly in line with long-run averages by the end of 2020. ... In the past two years, growth in sales of higher-end single-detached homes in several major markets has led to strong average MLS(R) price growth. In 2018, this composition effect has been fading (as shown in figure 4 and 5). As a result, in combination with higher borrowing costs and slower income growth, MLS(R) price growth is forecast to slow at the national level this year. By 2020, demand is expected to continue to shift towards relatively less expensive housing options such as apartment condominiums. This combined with slowing growth in economic conditions will lead to modest average price growth over the forecast horizon. (Source: CHMC)

The consensus view among economist at the various major banks is for a slowdown in growth in the province of Ontario and across Canada in 2019. The economic teams of the banks are projecting a growth to slow from above 2.0% in 2018 to just below around 1.8% in 2019 and 2020. They expect a similar trend to play out in the housing market as rising rates coupled with lower government spending precipitates a slowdown in consumer demand, business spending, and real estate transactions.

Ontario Economic Forecasts

As we go into the 2019 budget, businesses will be looking to the government to come up with strategies that will address the longer term competitiveness of Canada businesses. A key challenge that businesses are facing is the availability of skill people to meet changing demands. In spite over 300,000 immigrants coming in every year, Canada still faces a skill short fall. In addition, developments in Alberta where billions barrels of oil are landlocked, underscore the importance of the role of government in managing the infrastructure needs of the country such that its natural resources are fully and efficiently deployed. Finally, with the change in tax codes in the USA, businesses are heavily incentivized to redeploy capital to the USA a opposed to Canadian . We laud the government's effort to equalize tax rates between Canada and the USA by allowing for an accelerated tax depreciation on certain capital investments, but it is clearly insufficient to change the calculus given that the USA has a much wider range of positives for conducting business.

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