from Zero Hedge:
This Wednesday, the Bank of Canada has a decision to make.
Canada’s oil “dream” is dying thanks to the inexorable slide in crude prices and as the IEA made clear earlier today, the pain is set to persist for the foreseeable future as the world “drowns in oversupply.”
“Lower for longer” has hit the country’s oil patch hard. We’ve spent quite a bit of time documenting the plight of Alberta, where job cuts tied to crude’s slide have led directly to rising suicide rates, soaring property crime, and increased food bank usage (not to mention booming business for repo men).
Adding insult to injury for Canadians is the plunging loonie. Because the country imports most of its fresh fruits and vegetables, the weak currency has triggered a sharp increase in the price of many items in the grocery aisle as documented in a hilarious series of tweets by incredulous Canadian shoppers.
The question for the Bank of Canada is this: is the risk of an even weaker loonie worth taking if a rate cut has the potential to head off the myriad risks facing the economy?
We’ll find out what the BOC thinks tomorrow, but in the meantime, analysts have weighed in. JP Morgan’s Daniel Hui says CAD needs to fall further lest producers should simply close up shop. “[W]ith 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.”
None of those outcomes are particularly palatable. If the loonie continues to plunge however, it would act as a kind of shock absorber (producers’ costs are predominantly in CAD terms whereas the crude they sell is obviously denominated in USD), keeping CAD-denominated prices above 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 adds, driving the point home.
But this is a Catch-22. The BOC can cut and drive the loonie even lower thus allowing zombie producers to keep pumping and thus prevent still more oil patch job losses, but a falling CAD may have undesirable knock-on effects, like reduced consumer spending, for instance. Additionally, if uneconomic producers keep drilling and pumping, they’re just digging their own grave by contributing to an already oversupplied global market.
In short: there’s no “right” answer. “Economists are united in one view, that new plunges in oil prices, in the Canadian dollar, and weaker global financial conditions, make the Bank of Canada’s policy interest rate decision Wednesday a very close call,” MNI writes.
“We now are looking for a rate cut next week,” Bank of Montreal Chief Economist Douglas Porter told Market News. “We believe that the balance of weight has slightly tipped in favor of them going” for a rate cut, he added, pointing out that the market is pricing in a 50-50 chance of a BOC action this week.
Royal Bank of Canada assistant chief economist Paul Ferley, doesn’t agree. “We think that Governor (Stephen) Poloz will maintain his confidence that growth in exports will counter weakening business investment and he will hold the rate steady,” he says.
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