The Bank of Canada’s planned interest rate increase is at risk due to the ongoing slump in Alberta’s oil sector.
Alberta’s struggling oil industry is injecting significant uncertainty into the Bank of Canada’s plans for a potential interest rate increase in January. Economists are increasingly questioning whether the central bank will proceed with a rate hike, largely due to the dramatic collapse in prices for Western Canada Select, the nation’s primary heavy crude blend. Just weeks ago, a rate increase was considered almost certain, but now, doubts are mounting as the plunge in oil prices creates a major challenge for the Bank of Canada’s policy decisions.
Several leading financial institutions, including Toronto-Dominion Bank and Bank of Montreal, have altered their previous forecasts, adding asterisks to their calls for a January rate increase. Swap trading markets are also reflecting this shift in sentiment, with bets against a January hike falling from nearly fully priced in to approximately three-quarters, indicating a reduced probability of a move. The situation highlights the vulnerability of the Canadian economy to fluctuations in the energy sector, particularly the Western Canadian Select blend.
The core of the concern revolves around the unprecedented discount that Western Canada Select is experiencing. The blend closed at US$13.46 a barrel on November 15th, the lowest recorded level in Bloomberg data spanning back to 2008. This discount has exploded to as much as US$52.40 a barrel last month—also a record—exacerbating the challenges for the Bank of Canada. Economists believe that if the situation persists, “we would expect the Bank of Canada to hold off on raising its policy interest rate until there is further stabilization in oil prices,” according to a research note from Toronto-Dominion Bank economists Omar Abdelrahman and Brian DePratto.
Several economists are urging the Bank of Canada to seriously consider the implications of this oil price weakness. Bank of Montreal’s chief economist, Doug Porter, stated that he would contemplate canceling a call for a January rate increase if Canadian oil discounts continue. “The spread is so extreme, the cries of pain from Alberta are so loud, I don’t think they can just put blinders on and carry on as if no thing’s changed,” Porter said. While some remain confident that a strong overall economic picture—including healthy business conditions—will compel the central bank to raise rates regardless, the Alberta situation adds a significant layer of complexity and risk to the January decision.
Despite the caution, TD Bank anticipates that oil prices will ultimately recover, paving the way for a January rate hike. Economists predict that the discount for Western Canada Select could narrow to around US$20 a barrel over the next few quarters, aided by the potential easing of temporary supply disruptions. This recovery would allow the Bank of Canada to refocus on broader economic indicators, particularly those outside the energy sector, which has seen inflation rise above the Bank’s 2 per cent target.
However, some economists underscore the importance of acknowledging the province’s distress. Royal Bank of Canada’s Josh Nye, an economist, adds that while the overall economic picture is significant, the crucial balancing act is recognizing that “some provinces aren’t doing as well.” This perspective reflects the reality that the Canadian economy’s overall strength is intertwined with the performance of key sectors, particularly the energy industry.
The Bank of Canada’s next rate decision, scheduled for December 5th, followed by a speech from Governor Stephen Poloz the next day in Toronto, will be crucial in shaping market expectations. The extent to which Poloz addresses the Alberta oil price weakness will undoubtedly influence investor sentiment and potentially determine the Bank’s policy direction. The situation underlines the inherent challenges faced by central banks when navigating economies reliant on volatile commodity prices, demanding careful consideration and a nuanced understanding of regional economic disparities.
