Oil industry still guides BOC
Oil prices probably will guide the Bank of Canada through the early phase of the COVID-19 crisis.
The SARS epidemic of 2003 is of limited use since China wasn’t a central part of the global economy back then, but Canada’s central bank knows what to do when commodity prices tumble.
Governor Stephen Poloz approved two interest- rate cuts in 2015 to get ahead of the damage he knew would be caused by the collapse of oil prices at the end of 2014. He revisited that episode on Thursday in Toronto, where he gave his first public remarks since slashing the benchmark rate by a halfpoint some 24 hours earlier.
“We think it’s important, if possible, to get out in front, so we put the cushion in place before the economy begins to feel the confidence effects related to the virus,”
Poloz said at a press conference after his speech at a Women in Capital Markets event. “It’s not unlike what we did in early 2015, where it was clear that oil prices were dropping dramatically. The arithmetic around investment was clear. We spoke to all the companies. They told us how much they were going to cut spending. So we knew how big the shock would be long before it showed up.”
The arithmetic related to COVID-19 isn’t quite as simple yet. The number of reported cases in Canada is relatively small, so the economy hasn’t yet been frozen by the quarantines and cancellations that have befallen other countries. Poloz said the global economy could recover quickly from the coronavirus if the spread stops, but the outbreak could prove to be more persistent.
“At this point, we simply don’t know,” the governor said.
But he does know there will be at least some pain.
Commodity prices have dropped about 10 per cent since the start of the year, and oil prices have plunged by about 20 per cent. That’s not quite as severe as the collapse that happened at the end of 2014, from which Alberta still is trying to recover. Still, the dynamics are the same, and this time they are mixed with extremely volatile equity markets and economic growth that was already slow.
“Commodity prices are a very important channel for transmitting international shocks to the Canadian economy,” Poloz said in his speech. “With the oil- producing regions of our economy already stressed, this shock can only deepen and prolong the adjustment process.”
The oil- and- gas industry isn’t as important as it used to be, but it is still a foundation stone of the economy. And, unlike 2015, that economy had little momentum when commodity markets turned.
Growth slowed to stall speed in the fourth quarter, partly because of temporary factors such as the closure of a General Motors Co. plant in Oshawa, Ont., but also because “structural” issues persisted: business investment continued to disappoint, exports were weak and the housing market cooled. Even if “special factors” are ignored, the economy expanded at a rate of less than one per cent over the final three months of 2019. That’s a poor number. The central bank estimates the economy can grow at an annual rate of close to two per cent without stoking inflation.
“No question,” Poloz told reporters when asked if he and his deputies were leaning towards cutting interest rates even before COVID-19 emerged as an extreme threat. “We had a bias towards moving.”
The current situation is dire, but it is probably worth remembering that all is not lost. The bulk of Poloz’s speech was about the labour market, which he said is in “good health overall.” The jobless rate is about as low as it has ever been, participation rates are high and wages are rising faster than inflation. Consumer spending was also a bright spot in the fourth quarter, offsetting the negative effects of weaker investment and exports.
Lower borrowing costs should keep that engine revving, although the fight against panic will be constant. North American financial markets tumbled again Thursday, as relief from various rate cuts was overrun by fear that the virus is spreading in the United States.
It’s almost certain the Bank of Canada will cut interest rates again at its next policy meeting in April, assuming events don’t force it to respond sooner. “Poloz made it clear today that the bank sees COVID-19 as a serious threat to the Canadian economy, and one that comes at a particularly bad time given recent economic developments,” said Brian Depratto, an economist at Toronto- Dominion Bank. “The door to further easing is clearly open.”
GROWTH SLOWED TO STALL SPEED IN THE FOURTH QUARTER.
There were questions this week about whether lower borrowing costs would inflate housing bubbles in hot markets such as Toronto and Montreal. That seems likely, but Poloz pushed back against the notion in his remarks. If confidence crumbles, demand for housing would wane, risking a decline. In this way, lower interest rates could “stabilize” housing markets, he said.
Worries about financial stability kept the Bank of Canada from taking out insurance against the trade wars last year. It appears ready to do whatever it takes to stay ahead of COVID-19.
“Risk management demands a prompt and sizable policy response to larger shocks to ensure the economy remains well anchored,” Poloz said. “Governing Council agreed that the downside risks to the economy today are more than sufficient to outweigh our continuing concern about financial vulnerabilities.”