Skip to main content

The Globe and Mail

Can plunging oil price save global economy?

These are stories Report on Business is following Friday, June 22, 2012.

Follow Michael Babad and the Globe's top business stories on Twitter.

How much will lower gas prices help?
I had to pay almost $1.21 at the pump when I filled up last night, but I do appreciate that prices have come down. The big question is, how much will that help the global economy?

Story continues below advertisement

Ian Shepherdson, the chief U.S. economist at High Frequency Economics, says it should go some way to helping the cause in the United States, where, he believes, the spring surge was key in the slowdown.

Wholesale gas prices dropped about 4 per cent this week after holding steady in the first half of June, he said in a report, so the run-up has now been almost completely unwound.

Mr. Shepherdson runs through the math, calculating that Americans spent an average $551-billion (U.S.) a month, on an annualized basis, at the pumps in the first quarter of the year. That should fall to $531-billion in the second quarter and $500-billion in the third.

"If consumers were to spend all the cash flow gain immediately, the boost to GDP growth in the second quarter would be 0.5 per cent at an annualized rate, with a 0.8-per-cent kick in the third quarter," he said.

"Back in the real world, this is unlikely to happen in such a precise manner," he added in his report.

"We cannot be sure all the cash flow gain will be spent; some people will want to rebuild savings run down to ease the pain of the earlier run-up in gas prices. And even when the saving rate is stable, the lag between movements in gas prices and spending is variable. In recent years it has been about three or four months. This means we should expect to see retail sales begin to perk up in July and August, with the full effect visible in the late summer and early fall."

And, he added, there should be an effect on U.S. businesses.

Story continues below advertisement

"Almost all the payroll slowdown in recent months has been in the business services and leisure and recreation sectors, both of which are sensitive to gas prices," Mr. Shepherdson said.

"We think it is reasonable to expect employment in these sectors to rebound, boosting aggregate incomes," he added.

"At the same time, business confidence - and hence the willingness to undertake capital spending and build inventory - ought to be supported by lower gas prices, because consumer-facing companies will expect demand to increase."

Thus, the chances are good for a rebound in summer and early fall.

Andrew Kenningham, the senior global economist at Capital Economics in London, has something of a different take when it comes to oil and the global economy.

"The slump in oil price results from faltering global demand and growing fears of an escalation of the euro zone crisis," he said today.

Story continues below advertisement

"As such, it is wishful thinking to image that cheap oil can itself generate a recovery."

Mr. Kenningham doesn't see how a drop in oil prices can spark activity when weak demand is the reason for the drop.

"Cheaper oil may cushion the fall in demand, particularly in the U.S., where the pass-through from crude oil to gasoline prices is high," he said in his report.

"But it cannot reverse the slowdown. Nor will will cheaper oil do anything to resolve the financial and economic imbalances which threaten to break up the euro zone. So in short, cheaper oil may help, but not much."

Inflation slows
Consumer prices in Canada dipped 0.2 per cent in May, and the annual inflation rate fell sharply to 1.2 per cent, from 2 per cent a month earlier. That's the slowest pace of inflation since mid-2010.

The biggie was gas prices, which declined 2.3 per cent on a year-over-year basis, Statistics Canada said today.

The so-called core rate, which strips out volatile items and helps guide the Bank of Canada's monetary policy, also dipped, to 1.8 per cent on an annual basis from 2.1 per cent in April, The Globe and Mail's Ora Morison reports.

Not that the central bank was about to move on interest rates, anyway, but there was nothing in today's inflation report to get it particularly excited.

"Inflation is not exactly crowding the top of many worry lists at the moment, but it is nevertheless reassuring to see inflation receding rapidly as gasoline prices fade fast," said deputy chief economist Douglas Porter of BMO Nesbitt Burns.

"For the Bank of Canada rate outlook, this simply drives home the point that there is now precisely zero urgency to tighten. Even above and beyond the relentless concerns about Europe, as well as the new tighter mortgage rules, the domestic economic case for rate hikes in 2012 is crumbling, as both growth and inflation come in on the low side of expectations."

Assistant chief economist Dawn Desjardins of Royal Bank of Canada noted that the annual pace of inflation averaged 1.6 per cent in the first two months of the second quarter, below the central bank's forecast. However, the core rate continues to "come in on the high side of expectations" and appears headed for a second-quarter reading of 2.1 per cent.

"The sharp decline in energy prices in May was largely responsible for the undershoot on the headline rate but neither rate has deviated sufficiently from the bank's expected path to alter the outlook for monetary policy," she said.

Safe havens dwindle
Investors are fast running out of places to turn to, which raises questions about gold, and why it's becoming less of a safe haven.

Gold tumbled yesterday amid a general, and ugly, rout in stock and commodities markets, and now looks to be headed for its biggest weekly loss since December.

Bullion lost some steam this week when it became clear that the Federal Reserve would not "further debase" the U.S. dollar with another round of quantitative easing, said market analyst Chris Beauchamp of IG Index in London.

It's now well down from its peak of just over $1,900 (U.S.) and ounce last year.

Royal Bank of Scotland expects gold to climb again, averaging $1,800 by the fourth quarter, according to Bloomberg News today. But it will then begin to sink, its analysts say.

"From there, we reiterate our view that this move will be a 'last hurrah' for gold," the bank said. "We continue to see a downtrend commence from that point, which should see gold gradually fade to average $1,200 an ounce by 2015."

That $1,200 level is the point at which big gold miners see an impact on exploration and other spending.

"The markets feel weak but until gold breaks the all-important $1,527 level it's not worthwhile getting too bearish," TD Securities said today, noting that India reported gold imports slipped by $6.2-billion in April-May from a year earlier.

Generally speaking, Mr. Beauchamp's colleague, chief market strategist David Jones, believes German and U.S. bonds are "the safest thing apart from cash" at this point, and agrees that "the likes of gold definitely lost allure so far this year."

About that downgrade
Everyone knew it was coming, but the downgrade yesterday of the world's major banks by Moody's Investors Service was still a biggie.

The question is what it means.

The ratings agency hit 15 banks and securities firms, including Royal Bank of Canada.

Among the others were Bank of America Corp., Citigroup Inc., Credit Suisse Group AG, Goldman Sachs Group Inc., HSBC Holdings PLC, JPMorgan Chase & Co., Morgan Stanley, Credit Agricole, Barclays Bank, Deutsche Bank, Société Générale, UBS and Royal Bank of Scotland.

RBC's long-term deposit rating fell to Aa3 from Aa1, but it and two others, including HSBC and JPMorgan, are in a more stable group.

"Capital markets operations (and the associated risks) are significant for these firms," Moody's said of that particular group.

"However, these institutions have stronger  buffers, or 'shock absorbers,' than many of their peers in the form of earnings from other, generally more stable businesses. This, combined with their risk management through the financial crisis, has resulted in lower earnings volatility. Capital and structural liquidity are sound for this group, and their direct exposure to stressed European sovereigns and financial institutions is contained."

Analyst Peter Routledge of National Bank Financial doesn't see it as a big deal.

"RY now belongs to a smaller, more exclusive, group of three global banks rated in the Aa category; prior to the downgrade it was one of 10 in this category," he said of RBC, referring to the bank by its stock symbol.

"To the extent they use ratings in weighing counterparty risk, the chief risk officers of RY's counterparties will, we believe, beneficially distinguish the bank from its peers even more than before today's rating action ... Downgrade is a non-event for equity holders. While the downgrade is larger than expected, our view on RY remains unchanged. It has a premier domestic franchise and strong risk management. Over the long-term we expect the bank to deliver attractive returns to shareholders."

Report an error
As of December 20, 2017, we have temporarily removed commenting from our articles. We hope to have this resolved by the end of January 2018. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to If you want to write a letter to the editor, please forward to