Top Economic Drivers of 2017:
The beginning of a new year marks a time of planning. The FCC Ag Economics team wants to help you put your best foot forward into 2017 with an in-depth look at the top five economic drivers affecting Canadian agriculture this year. Check out the first post in this series and stay tuned over the following weeks as we dive into each driver in more detail.
Agriculture has always been a capital intensive industry – requiring working capital to purchase feed, seeds, etc. as well as long-term capital to finance equipment and land purchases. Emerging food trends and competitive pressures will require businesses to continue making investments. For these reasons, we’ve named interest rates as our fourth trend to monitor in 2017.
The investment landscape in agriculture and agri-food will remain favorable over the upcoming year. The Bank of Canada (BoC) projects economic growth to hit 2.1% in 2017, after a year in which the Canadian economy is believed to have grown at 1.3%. Despite this acceleration, the BoC hasn’t signaled an intention to raise its key policy rate (the overnight rate) off the current 0.5% level.
What can Canadian ag expect from interest rates in 2017?
Investments start with the cost of capital (interest rates). While the Canadian economy is expected to grow in 2017, there are a few headwinds keeping the economy below its full potential:
- Slowing economic growth in emerging countries could keep the demand for commodities muted
- Oil prices are uncertain and volatile
- Level of household debt remains elevated relative to income
With inflation expected to remain around 2%, we don’t expect the BoC to change its target for the overnight rate in 2017.
A constant overnight rate doesn’t mean steady borrowing costs. The average business interest rate in Canada has declined for most of 2016, bringing borrowing costs to historically low levels. A slight trend reversal has emerged in the last couple months of 2016. Is this upward trend in borrowing costs likely to continue?
The answer begins south of the border. Investors’ confidence in the U.S. economy is climbing, bringing up bond yields and overall U.S. interest rates. The U.S. federal reserve hiked its key interest rate by 0.25% last December, and projected more increases (as many as four) will be needed to fight off expected rising inflation. Because financial markets are integrated, this trend has also brought up bond yields in Canada. We project borrowing costs will keep rising in 2017, albeit at a moderate pace.
The decision to invest is also a function of the expected rate of return associated with a project. The outlook for the Canadian agri-food supply chain is encouraging. A strengthening U.S. economy is positive for the entire Canadian agri-food supply chain. Over 70% of food exports go to the U.S. market while Canadian agricultural exports to the U.S. represent 30% of Canadian ag GDP. A low Canadian dollar will keep the demand for Canadian agricultural commodities strong in 2017. This should support an above-average return on farm assets rate.
What’s the bottom line?
Canadian agriculture is a capital-intensive industry and benefits from a low interest rate environment. Despite a projected slight upward trend in borrowing costs in 2017, interest rates remain at historically low levels.
While we’re not anticipating a major increase in interest rates in 2017, the level of uncertainty in the world economy is a real consideration. Businesses should regularly review and revise their financial situation to understand and respond to changes in interest rates. And always remember, an environment of tighter profit margins calls for investments in improving efficiency and increasing productivity.