MNI: Weak CAD-Oil Link Raises BOC Hike Chances- Former Staffer

Canada's central bank is more likely to consider a rate increase this year because the weakening link between its dollar and higher oil prices adds to inflation risk, a former BOC and finance department economist told MNI, though he added that economic headwinds meant rates were more likely to stay on hold.

“The distribution has shifted towards a potential hike just because of the potential impact on inflation and the fact that the Bank of Canada will not want to repeat the same scenario in 2023 where in some ways they were late at fighting inflation,” said Charles St-Arnaud, now chief economist at Servus credit union. 

Governor Tiff Macklem has said the era following Covid and energy prices boosted by the Ukraine war was the most difficult since Canada became the first G7 central bank to adopt inflation targets in the 1990s. Officials went from suggesting a long period of the policy rate at a record low 0.25% to hikes including a 100bp move that took the benchmark to 5% by mid-2023. 

Avoiding a repeat of that policy lurch may influence the Bank's thinking today, St-Arnaud said. “We still all have a lot of PTSD from that, 2022- 2023 period, and I think the Bank has a lot of it.”

Companies may also use higher gas prices as cover for other increases, he said. “The general public expects higher inflation, so businesses are willing to pass on the full cost and not absorb any of it, because they know they're not going to face push back.”

CANADA LEAKING OIL MONEY

Canadians face relatively higher import prices with Canada's dollar losing much of its historic tendency to strength in commodity booms, St-Arnaud said. Energy firms are keeping more of the windfall in U.S. dollars, further sapping Canada's currency, he said. 

“Revenues from higher oil exports are not staying in Canada because oil producers are returning a greater share of those revenues to shareholders, actually 75% of them are not Canadian,” St-Arnaud said. “If you go back to 2014 at the top of the oil boom, they were returning about 30% of the of their revenues into their operation in terms of capex. Now it's about 10%.”

Corporate borrowing is also often in U.S. dollars and firms are only converting back into Canadian dollars needed to fund local operations, he said.

Reduced benefits from higher energy prices add to the case for the Bank to hold rates this year -- St-Arnaud's base case. A significant danger is Donald Trump's threats of more of the big tariffs that pushed Canada towards recession last year. 

“There are still a lot of headwinds on the economy where they will want to be very careful and very convinced that inflation is real,” St-Arnaud said. (See: MNI INTERVIEW: BOC 'Straddling Both Sides' In Rate Hold-Stillo)

MAKING AN ACTIVE CALL

But, in a hiking scenario it’s hard to tell if the Bank can keep inflation under control with hawkish language and mild tightening or if a big move will be needed, he added. 

“There is more of a tug of war between factors that would require lower rates and factors that would require higher rates,” he said. “What do all those higher prices do to inflation? And that's where it really depends on how long oil prices remain high.”

St-Arnaud's expectation is Strait of Hormuz oil shipments resume in coming weeks because the global stakes are so great. Asian nations in particular may pay Iran's tolls, he said.  “When the choice is between running out of oil and the economic and social consequences of that or paying a toll to Iran … you probably go and choose a greater cost.”

Bank officials may be pressured into making a choice later this year, St-Arnaud suggested. “Whether they think it's going to be longer lasting will matter for their monetary policy, will matter for inflationary pressure” he said. “They will need to make an active call on that.”