Low oil prices drag­ging down Cana­dian econ­omy

Calgary Sun - Homes - - Homes - MYKE THOMAS

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Last sum­mer, the Bank of Canada in­di­cated it in­tended to raise its overnight lend­ing rate to what it calls a neu­tral rate of be­tween two-and-a-half and three per­cent through the course of 2019. This was pred­i­cated on the as­sump­tion the Cana­dian econ­omy would con­tinue to grow.

This past week, the Bank did an about-face and left its rate at 1.5 per­cent, cit­ing the price of oil as be­ing a drag on the na­tional econ­omy.

“The drop in global oil prices has a ma­te­rial im­pact on the Cana­dian out­look, re­sult­ing in lower terms of trade and na­tional in­come,” said the Bank in a state­ment. “As well, trans­porta­tion con­straints and ris­ing pro­duc­tion have com­bined to push up oil in­ven­to­ries in the West and ex­ert even more down­ward pres­sure on Cana­dian bench­mark prices. While price dif­fer­en­tials have nar­rowed in re­cent weeks fol­low­ing an­nounced manda­tory pro­duc­tion cuts in Al­berta, in­vest­ment in Canada’s oil sec­tor is pro­jected to weaken fur­ther.”

This is good news and bad news. The bad is a weaker oil sec­tor. The good news is the sec­tor is af­fect­ing the na­tional econ­omy, which should make the rest of Canada take no­tice of what is caus­ing the sec­tor to be weaker, which is a lack of pipe­lines.

“These de­vel­op­ments are oc­cur­ring in the con­text of a Cana­dian econ­omy that has been per­form­ing well over­all,” said the Bank. “Mean­while, con­sump­tion spend­ing and hous­ing in­vest­ment have been weaker than ex­pected as hous­ing mar­kets ad­just to mu­nic­i­pal and pro­vin­cial mea­sures, changes to mort­gage guide­lines and higher in­ter­est rates. House­hold spend­ing will be damp­ened fur­ther by slow growth in oil-pro­duc­ing prov­inces.”

Craig Alexan­der, Deloitte Canada’s chief econ­o­mist, told sev­eral hun­dred hous- ing ex­ec­u­tives at a BILD Calgary Re­gion din­ner last week that he ex­pected the Bank’s de­ci­sion.

“This came as no sur­prise be­cause fi­nan­cial mar­kets had priced out any rate hike in Jan­uary in the wake of the tum­ble in oil and in light of the volatil­ity of the stock mar­ket in De­cem­ber,” said Alexan­der. “The Bank of Canada said it still be­lieves that they will ul­ti­mately need to move in­ter­est rates back to what they con­sider to be neu­tral. I would ar­gue that the neu­tral for Canada is ac­tu­ally the bot­tom of that range. Most fore­cast­ers were fore­cast­ing the Bank of Canada would take the overnight rate up to two-and-a-half per­cent in 2019 and I don’t think they’re go­ing to get there. I think ul­ti­mately by the time we get to­wards the end of this year, I think they’re go­ing to re­al­ize the econ­omy isn’t as strong and I think we’re go­ing to get a half of a point in­crease in in­ter­est rates this year and I think there’s a grow­ing case that they re­main on hold.”

A small in­crease or keep­ing the rate on hold is good news for prospec­tive home buy­ers be­cause ris­ing rates make the mort­gage stress test more se­vere.

Alexan­der ex­pects the na­tional econ­omy to level out.

“We are go­ing to see busi­nesses out­side the en­ergy patch in­vest­ing more be­cause ca­pac­ity uti­liza­tion is run­ning at very high lev­els,” he said. “I think we are go­ing to see ex­ports ben­e­fit­ting from a weak Cana­dian dol­lar, but fun­da­men­tally the ex­ports and in­vest­ment can’t pick up the slack in the mod­er­a­tion in hous­ing and con­sumer spend­ing and that’s why eco­nomic growth drops down to less than two per­cent.”

Last fall, Alexan­der had high ex­pec­ta­tions for the Al­berta econ­omy.

“As De­cem­ber un­folded, I got less en­thused,” he said. “My fore­cast for Al­berta was for growth of 2.3 per­cent, ba­si­cally neck and neck with B.C. for the fastest rate of eco­nomic growth, but now Al­berta is be­low the mid­dle of the pack of prov­inces in terms of growth.”

Alexan­der up­dated his fore­cast be­cause of oil.

“The drop in oil prices and oil pro­duc­tion cur­tail­ment knocks Al­berta’s eco­nomic growth rate down from 2.3 per­cent to about 1.3 per­cent,” he said. “The pro­duc­tion cur­tail­ment has had the de­sired im­pact in nar­row­ing the spread be­tween West Texas In­ter­me­di­ate crude and West­ern Canada Se­lect prices.

“How­ever, what we’re talk­ing about is real gross do­mes­tic prod­uct. Gross do­mes­tic prod­uct is the value of all the goods and ser­vices we pro­duce. The real GDP strips off prices. If you put in place an oil pro­duc­tion cur­tail­ment, you re­duce the pro­duc­tion in or­der to lose the cri­sis. When you boost the prices but you cut the pro­duc­tion, you lower your real GDP be­cause it doesn’t cap­ture price ef­fects, so ul­ti­mately the cur­tail­ment com­bined with lower oil prices will con­strain in­vest­ment in the en­ergy patch that is go­ing to lead to weaker eco­nomic growth.”

And an ef­fect on hous­ing.

“The real es­tate mar­ket is di­rectly a func­tion of how the econ­omy is do­ing and so I think we are go­ing to see a weaker pace of con­struc­tion, but well above what we had in 2015/2016,” said Alexan­der. “I think prices have al­ready started to dip, but one thing that lim­its the im­pact of prices is what will be hap­pen­ing to list­ings. As list­ings drop, it will con­strain new sup­ply and con­strain­ing new sup­ply will limit the im­pact on pric­ing.

“I think we’ll see sin­gle-digit price de­clines in Calgary this year, re­flected by a weaker econ­omy and then in 2020, I think we’ll see some price growth but, again, I think it will be in the low sin­gle-dig­its.”

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