The crisis in Canada’s oil patch is threatening to stall efforts by the Bank of Canada to get its key interest rate back up to a more normal level.
As widely expected, the central bank kept its key rate unchanged at 1.75 per cent on Wednesday after five rate increases since mid-2017.
Governor Stephen Poloz and his central bank colleagues pointed to a clutch of negatives now weighing on the Canadian economy that could slow the pace of future rate hikes, including the steep price discount on Canadian crude, uncertainty hanging over business investment and the U.S.-China trade showdown. The bank also highlighted the possibility that the economy could still grow more rapidly without sparking inflation.
“The persistence of the oil price shock, the evolution of business investments and the bank’s assessment of the economy’s capacity will also factor into our decisions about the future stance of monetary policy,” the bank said in statement on the rate announcement.
The Canadian dollar was down more than half a cent in midday trading following the announcement amid fading expectations that the bank will hike again in January.
It isn’t quite a “mea culpa or a 180-degree turn,” but Mr. Poloz is definitely trying to “walk back” the rate-hike expectations he planted just six weeks ago, said David Rosenberg, chief economist and strategist at Gluskin Sheff in Toronto.
The Bank of Canada isn’t likely to stop raising rates because of the oil price slump, but it appears to be in less of a rush than it was, Toronto-Dominion Bank economist Brian DePratto said in a research note.
“While everything points to a January hike being off the table, the path thereafter is less clear,” he said.
Mr. Poloz will have a chance to clarify the bank’s thinking when he delivers a speech in Toronto Thursday.
The Bank of Canada’s new tone could affect both the pace and the eventual high point for the bank’s key interest rate. Before Wednesday, investors had priced in a roughly 64-per-cent chance that the central bank would hike by a quarter of a percentage point on Jan. 9, when it releases its next set of forecasts. Economists had expected up to three rate increases in 2019.
Trouble in the oil patch has apparently disrupted that narrative. The Bank of Canada said the oil price shock and Alberta’s decision this week to curb production means “activity in Canada’s energy sector will likely be materially weaker than expected.”
A January hike is now dependent on “much better economic data for October” plus an oil production cut from the Organization of the Petroleum Exporting Countries, CIBC chief economist Avery Shenfeld said in a research note.
Heavy crude from the Alberta and Saskatchewan oil sands has been selling at near record-low levels in recent weeks amid a widening price gap with the North American oil benchmark, West Texas Intermediate. The price of heavy crude, which had tumbled to less than US$15 a barrel, has since bounced back to more than US$28 a barrel. But transportation bottlenecks and high inventories remain a serious problem for the Canadian industry.
The Bank of Canada had previously said it was on a course to raise its rate to what’s called a neutral level – where it is neither spurring economic activity, nor slowing it down. The bank has estimated that its neutral rate is between 2.5 per cent and 3.5 per cent.
Many economists assumed that neutral was probably the midway point of 3 per cent, but after a recent speech in Britain, Mr. Poloz suggested that neutral is a moving target. The neutral rate, he told reporters, is “sufficiently uncertain” and “in principle, movable.”
“All we know is that as we get closer to it, whatever it is, we’ll begin to see signs that we’re no longer stimulating demand,” he explained at the time.
The bank may be leaning toward the lower end of its range, rather than the middle. The statement pointed out that recent “downward historical revisions by Statistics Canada to GDP, together with recent macroeconomic developments, indicate there may be more room for non-inflationary growth.”
Beyond oil and global trade, the Bank of Canada said the economy has been evolving pretty much as expected. Inflation is on target, the housing market is cooling down and business investment outside the oil patch is poised to strengthen.