The continued plunge in crude oil prices (the commodity is now worth less than water and milk) has put the Bank of Canada between a rock and a hard place. While the Canadian economy is reasonably diversified compared to countries like Venezuela or Saudi Arabia, it is still relatively dependent on crude oil and other commodities, The ongoing decline in commodity prices has hit Canada’s economy hard, and related to this, the Canadian dollar has also taken a beating over the last several months.
The normal cure for a weak economy, of course, is lower interest rates, but lower interest rates also typically lead to further declines in a country’s currency, arguably the last thing the already battered Canadian consumer needs right now. The BOC is meeting on Wednesday, and analysts say it is a toss up whether the central bank will cut rates further from the current 1% or stand pat for now.
“We now are looking for a rate cut next week,” Bank of Montreal Chief Economist Douglas Porter noted in an interview this week. “We believe that the balance of weight has slightly tipped in favor of them going” for a rate cut, he continued, highlighting the market is currently pricing in a 50% chance of a rate cut by the BOC this week.
JPM says Canadian Loonie likely to fall further
According to the latest report from JP Morgan’s Daniel Hui, the Canadian dollar needs to drop further to protect Canadian oil producers. Hui notes: “With West Canada Select (WCS) now sitting just a dollar above the average per-barrel operational cost of $20 (Canadian), the risk is that any further decline will cause a whole new host of spillovers including potential shutdown and retrenchment of energy extraction and exports (with its attendant growth and balance of payment effects) or the potential of highly leveraged companies running operational losses, and the more contagious financial impact that might have in Canada, with broader spillovers.”
Keep in mind that the Loonie continuing to drop actually serves as a buffer, given producers’ costs are based on the CAD and the crude sold is denominated in USD, helping to maintain CAD-denominated prices higher than the marginal cost of production.
“One of the few scenarios that would keep bitumen producers above marginal cost amid a further decline in global energy prices, is for CAD to depreciate substantially and at a much higher beta to oil price than has been the case in the past 18 months,” Hui says.
Negative interest rates coming to Canada too?
Other analysts have gone so far as to suggest that negative interest rates will soon be coming to Canada as well. Remember that the BOC has explicitly noted that negative interest rates are a potential policy tool. “The effective lower bound for policy rates is around -0.5%,” BOC governor Stephen Poloz commented in December.
IceCap Asset Management is willing to go out on a limb and say that negative interests rates in Canada are almost inevitable. IceCap says without a notable bounce in the price of oil, we can expect:
- The Canadian economy to be in recession in 2016
- The Bank of Canada will be at 0% interest rates in 2016
- The Bank of Canada will be at NEGATIVE interest rates in later 2016
- The Bank of Canada will be PRINTING MONEY in later 2016
CIBC concurs stating:
Many Canadians view the exchange rate as a temperature gauge on the country’s economic well-being. Screaming headlines are overstating the implications for consumers, focusing on selected goods with the highest import content in final prices. But these reports could have real implications for consumption, even of domestic goods, if Canadians judge every drop in the loonie as a sign of impending economic doom.
After an additional rate cut, it might be hard to suppress talk of negative rates and QE ahead.
If the Canadian dollar was on a gentle glide path, that wouldn’t be a problem. But there’s a risk that, with the C$ already in a steep decline, the rush to sell our currency will accelerate and crush household confidence. In that sense, a rate cut would be playing with fire, and a dovish statement that left the door open for further easing would be safer.
Even better would be a clear signal from the Finance Minister that the government is open to a much larger fiscal stimulus package than previously discussed. That would actually help shore up the C$, by reducing the odds that QE or negative rates will be required. Contrary to popular wisdom, fiscal stimulus makes for a stronger exchange rate, while restraint that acts as a drag on growth weakens the currency. If we want to avoid the shock of a 60-cent Canadian dollar, we’ll need to use the fiscal weapon rather than more monetary ease