Bank of Canada rate cut could be affected by rising oil prices

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Oil prices hit a five-month high this week, and economists say that could be “somewhat concerning” to the Bank of Canada as it assesses the right time to cut interest rates.

West Texas Intermediate crude oil futures rose above $85 on Tuesday, the highest since October, boosted by production cuts by the Organization of the Petroleum Exporting Countries (OPEC), resilience in major economies and escalating conflict in the Middle East.

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“I think this is an issue that could prevent the Bank of Canada from cutting rates or cutting rates significantly,” said Douglas Porter, chief economist at Bank of Montreal. “They will be a little worried. There are obviously a lot of factors that drive inflation… but ultimately energy prices and headline inflation could play a pretty big role in what the bank decides. there is.

Economists expect the Bank of Canada to announce its first rate cut in mid-2024. But those predictions could change after oil prices have been on an upward trajectory over the past month, hitting a five-month high on Tuesday following Israel’s airstrike on the Iranian embassy in Syria.

The rise in oil prices isn’t extreme – there was an even bigger price rise when Russia started war with Ukraine, for example – but the longer they stay up at this point, the worse the situation will be for the Bank of Canada. That’s going to be a problem, Porter said.

“Oil prices have exceeded our expectations,” he said. “If oil prices remain under sustained pressure, that certainly puts a question mark on the Bank of Canada’s overall outlook for rate cuts.”

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But BMO economists also said that while not unheard of, it is “quite unusual” for the bank to specifically cite oil prices as a driver of policy. For example, the Bank of Canada cut interest rates in 2015 in response to falling oil prices.

Mark Arcolao, an economist at Toronto-Dominion Bank, said he would not be surprised if the Bank of Canada cited rising oil prices as a potential risk to inflation. But he doesn’t think the current situation will have a major impact on central banks unless oil prices rise further, which he doesn’t expect.

“If oil prices reach above $90 per barrel, the trajectory of inflation is likely to change,” he said. “But it’s now April, and the Bank of Canada has a few more months to evaluate the incoming data. In the meantime, oil prices are unlikely to rise sharply enough to cause the bank to reconsider cutting rates. It won’t affect you.”

Higher oil prices could provide a much-needed boost to Canadian oil producers, which suffered a slump in 2023, and could also benefit the economy.

Elcolao said the budgets of oil-producing states estimate WTI prices at $74 to $78 per barrel. Higher prices mean more income, which could help address the deficit, he said.

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“It’s not bad for the economy,” he said. “We expect the situation to moderate again after 2025, especially if we achieve the goal of reaching net zero by 2030. This is inconsistent with some of the investments in oil production.”

But rising prices will also hurt consumers. Mr Porter said that while there was “a lot of attention on the carbon tax”, the “main driver” of petrol prices was the price of oil.

Both Porter and Ercolao don’t expect oil prices to fall much this year. According to Reuters, OPEC decided on Wednesday to maintain its existing production cut plan until mid-year. So far, the organization has removed about 6 billion barrels a day since cuts were introduced in 2022, Ercolao said.

“We’re looking to see if that extends into the third or fourth quarter,” he said. “This could create upside risks in the second half of the year.”

• Email: nkarim@postmedia.com

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