January 15, 2008 / 12:22 AM / 10 years ago

Firms face mounting capacity, credit pressures

OTTAWA (Reuters) - The portion of Canadian companies with difficulty meeting increased demand rose to a new high in the fourth quarter of 2007, despite slower economic growth and a lower inflation outlook, a Bank of Canada survey showed on Monday.

In its fourth-quarter Business Outlook Survey, the bank found that 60 percent of firms reported "some difficulty" or "significant difficulty" in meeting an unexpected increase in demand, up from 54 percent in the third quarter.

Most of the pressure came from the services sector and in Western Canada, the bank said in its report.

"Labor continues to be the most commonly reported constraint in production capacity," it said.

The results of the survey suggest that while the central bank has room to cut interest rates, it may be cautious not to lower borrowing costs too aggressively.

Economic growth in Canada slowed to 2.9 percent in the third quarter from 3.8 percent in the second quarter. Economists expect 2.3 percent growth in the fourth-quarter as the weaker U.S. market hampers exports.

The Bank of Canada pays particularly close attention to the survey results on capacity constraints, which can fuel inflation.

It is widely expected to lower its key overnight interest rate on January 22 for the second time since December as the U.S. housing crisis, a strong Canadian dollar and tight credit dampen growth prospects.

But the bank is likely to tread carefully when pondering additional cuts because of signs that economic activity continues to expand at a rate that could trigger higher inflation.

"This supports our view that while the Bank of Canada does have some room to maneuver in cutting interest rates, given the capacity pressures in the economy, they cannot afford to cut rates too far, and will only likely deliver two more 25 basis points rate cuts before sitting back and remaining on hold," said Jacqui Douglas, economics strategist at TD Securities.

Sal Guatieri, senior economist at BMO Capital Markets, said increased uncertainty about the economic outlook points to further moderation in growth and less capacity pressures in 2008.

"The door remains open for further monetary easing in the months ahead, though still tight capacity will keep the pace of rate cuts mild," he said.

Sixty percent of firms said credit conditions had stayed the same in the fourth quarter compared with the previous quarter, but 32 percent said borrowing had become even tougher.

A shift toward tighter credit was first noted in the third quarter, a reflection of the global credit crunch that began in August, but the Bank of Canada did not publish those results. It released the data on this question for the first time in Monday's report.

Despite growing capacity pressures, as well as labor shortages for 41 percent of the companies surveyed, more firms expect inflation over the next two years to be at the lower end of the central bank's target range of 1 percent to 3 percent.

Thirty percent expect inflation of between 1 percent and 2 percent, up from 16 percent in the previous quarter. Overall, 86 percent expect consumer prices to stay within the target range.

Reporting by Louise Egan; Editing by Rob Wilson

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