The Canadian economy was dealt a serious blow on Monday as a combination of sharply lower oil prices and the coronavirus outbreak leaves the country bracing for a downturn.
Benchmark oil prices tumbled about 25 per cent on Monday after the Organization of the Petroleum Exporting Countries failed to agree on production cuts last week, leading Saudi Arabia to slash its crude prices and raising the prospect of substantially higher production levels that keep prices subdued for an extended period.
Markets were thrown into turmoil, with Canada’s benchmark stock index plummeting by 10 per cent on Monday, its steepest one-day loss since 1987. Some Canadian oil producers saw their values erode by more than 50 per cent within hours.
Finance Minister Bill Morneau said Monday that Ottawa will unveil a response this week to protect against mounting economic risks posed by the COVID-19 outbreak and lower oil prices.
“We have the capacity to deal with challenges exactly like this,” Mr. Morneau said, singling out the tourism and energy sectors as those facing “real challenges."
The Canadian economy nearly ground to a halt in the final quarter of 2019, although a rebound was expected this year as temporary disruptions, such as a CN rail strike and a partial Keystone pipeline closure, faded. But with the emergence of COVID-19 and its rapid spread throughout the world, the economic outlook has worsened at home, and lower crude prices have delivered another headwind to growth prospects.
“If oil prices are suppressed for a significant period of time, it will represent a major negative shock for the Canadian economy, and not just for the oil-producing provinces,” said Brett House, deputy chief economist at Bank of Nova Scotia.
Already, the Bank of Canada has cut interest rates by half a percentage point and federal spending appears imminent to protect the economy against downside risks.
Even then, the Canadian economy appears to be in a vulnerable position, and growth could slow to a crawl – if not decline outright – as virus fears and weaker commodity prices weigh on business activity.
“At least one quarter of negative [gross domestic product] growth now looks likely,” Stephen Brown, senior Canada economist at Capital Economics, said Monday in a client note. The research firm expects real GDP to decline by 1 per cent in the second quarter, before rebounding to 0.5-per-cent growth in the third.
“But that low rate means it would not take much more to tip the economy into recession,” Mr. Brown added.
Bank of Montreal has also projected a contraction in the second quarter, and its next forecast will show 2020 growth cut in half – to 0.5 per cent from 1 per cent –assuming U.S. benchmark West Texas intermediate averages US$40 a barrel over the course of the year.
“Does the weakness we're likely to see in the second quarter morph into something more serious in the third quarter, or do we stabilize and begin to pull out of it later this year?” said BMO chief economist Douglas Porter. “That's really where it becomes critical for fiscal policy to get this right to support the turnaround in the economy in the second half of the year.”
Speaking with reporters late Monday afternoon, Mr. Morneau said the government is reviewing a range of potential measures to respond to the recent economic shocks and some will be announced this week, though he declined to outline any specifics. He said measures will be announced as they are ready and warranted, and he positioned the upcoming federal budget, for which a date has not been set, as just “one piece” of that response.
“In terms of moving forward on measures that we can actually use to assure people that we’ve supported them, that we’ve supported their organizations if necessary, we’re working on some responses right now,” he said. “What you’ll see from us is a continued approach where, as we have measures that we think are appropriate to roll out, based on the facts, we will do so. And you’ll see some things this week.”
As he considers his options, Mr. Morneau said he has had “extensive discussions” with leaders in the banking and energy sectors, as well as his domestic and international colleagues.
On Friday, Mr. Morneau gave a speech that did not signal any plans for short-term stimulus and instead promised to set aside a larger adjustment for risk in the budget – which is normally $3-billion per year – so that money is available for future spending or tax cuts if necessary. He also said his government remains committed to reducing the federal debt as a share of GDP.
“Not much fiscal support can be expected in the near term as long as the government sticks to its fiscal anchor,” said Rebekah Young, Scotiabank’s director of fiscal and provincial economics, in a research note. Doubling the risk provision to $6-billion “would not shift the needle substantially against an economy slowing abruptly and may be too late by the time it is allocated and deployed,” she added.
Experts have suggested various ways the federal government could step in, ranging from cash transfers to Canadian households to tax holidays for some businesses.
“At a minimum, you probably need more money dedicated to health care,” said Craig Wright, chief economist at Royal Bank of Canada. “But more broadly than that, it’s making sure that businesses and consumers are cushioned somewhat through this slow-growth period.”
Further monetary easing appears on the way. Bond market indicators imply that traders now expect another half-percentage-point cut when the Bank of Canada issues its next rate decision, along with new economic projections, in mid-April.
Some economists believe the central bank may be headed much lower.
“Revisiting the [financial] crisis lows of 0.25 per cent looks like it is unavoidable, barring a sharp positive turn,” BMO economist and strategist Benjamin Reitzes said, referring to 2009.
Mr. Reitzes said that unless there’s “a forceful rebound” in oil, the price slump would not only put a major dent in the Bank of Canada’s expectations for income from exports, but would further threaten the already depressed capital spending intentions in the resource sector – thus inflicting a “second round” of damage to growth. That’s similar to what happened in 2015, when the bank cut rates twice in the face of a deep drop in oil prices.
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