While the rally in oil prices threatens to be a drag on global growth, it’s a good thing for Canada, the world’s fourth-largest producer.
Yet whether the benefits are large enough to make a big difference is an open question, given doubts around the sustainability of the price increases and obstacles to investment like rail and pipeline constraints. While more expensive oil should reinforce expectations that borrowing costs are eventually going higher, most economists predict little impact on growth, and views are mixed on what it means for the Bank of Canada’s projected rate-hike path in the near term.
Bloomberg spoke with economists at the five largest Canadian banks on what higher oil prices will mean for the economy and interest rates.
According to Bank of Nova Scotia economist Derek Holt, the mere fact oil prices are moving higher has hawkish implications for the central bank and could potentially move the dial on rate increases.
The most immediate impact on the economy is a boost to national income. Even if Canada doesn’t produce an extra barrel of oil beyond the roughly 4.9 million it churns out daily, higher prices mean more money in the oil industry’s pockets and that will spillover into wages, jobs and tax revenue.
Higher oil prices “fit into a broader picture that suggests there should be no hesitation to continue along a hiking path in the near term,” Holt said.
While corporate profits will rise and some of that will eventually spillover into the rest of the economy, the pass-through effects aren’t what they once were.
Right now, pipeline constraints seem to be the primary determinant of investment. The industry is also being hampered by rail bottlenecks and a less-favourable tax environment after U.S. President Donald Trump cut U.S. corporate taxes. So, it’s less clear what impact higher prices will actually have on oil production and investment.
The Bank of Canada’s latest quarterly forecasts were based on the assumption of West Texas Intermediate oil prices at US$60 a barrel, which is about US$10 dollars less than its current value. According to Royal Bank of Canada economist Mark Chandler, a $10-a-barrel difference implies under normal conditions a reduction in slack by about 0.25 per cent of gross domestic product. But some of these channels between oil prices and investment have been “compromised,” he said.
“It helps incomes,” Chandler said. “It doesn’t really help GDP directly.”
There is also the issue of whether the recent jump in oil prices is sustainable. Slowing global growth and the possibility of a more favourable solution to the Iran situation than feared suggest the current mark-up in oil prices isn’t justified, according to Bank of Montreal economist Michael Gregory, who sees fundamentals for oil closer to US$60 a barrel. Gregory said his hunch is the Bank of Canada probably sees it the same way.
“Bottom line, they will look past it,” Gregory said. “Overall, this is neutral to slightly more encouraging for the Canadian economy but not to the point where it turns the dial on any risk or maybe gets the Bank of Canada to increase proclivity to do something.”
The same argument goes for inflation. While higher oil prices will only fuel the pick up expected this year, Bank of Canada Governor Stephen Poloz has said he’s not worried about price gains above his two-per-cent target as long as they are temporary.
It’s “unlikely to spur an aggressive reaction from central bank officials,” said Royce Mendes, an economist at CIBC World Markets. “They are trying to look for evidence of an economy that is overheating. Higher oil prices are not really evidence of that.”
Whatever the benefits from the pick up in oil prices, they still won’t be enough to offset the list of concerns that have been troubling the Bank of Canada recently. Foremost among those are talks to revamp the North American Free Trade Agreement, and the large levels of debt some households are carrying.
“Broadly speaking this is a fairly positive development — particularly for the oil sector, the profitability story, the income story — but again they are balancing this out against very, very stretched household finances,” said Brian DePratto, an economist at Toronto Dominion Bank. “The balance of things suggest continued caution.”