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Hike in gas took $1-billion from other spending, saving

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Gas pains Canadians are fretting ever more about high gas prices, which spiked this week in many regions of the country and renewed talk of how fuel costs could bite into the economic recovery.

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BMO Nesbitt Burns, for one, studied the potential impact of a sustained 30-per-cent jump at the gas pump, which would take costs to about $5 (U.S.) a gallon in the United States and Canadian prices to about $1.70 a litre.

That, said BMO senior economist Sal Guatieri, would trim annual economic growth by more than a full percentage point, driving up unemployment in Canada and the United States and killling this year's stock rally.

Amid tensions related to Iran that have pushed up oil prices, economists have warned that high crude could derail the recovery. Countries such as the United States, Britain and France, in turn, have discussed tapping their oil reserves.

"Although crude oil prices are expected to hover near $100 a barrel in the year ahead, the risk of a near-term spike is elevated due to potential supply disruptions," Mr. Guatieri said.

"The rising cost of imported overseas oil, together with a shortfall in domestic pipeline capacity, has forced about one-third of U.S. East Coast refineries to halt operations; meanwhile, the Iranian situation could disrupt oil shipments in the Strait of Hormuz, a key route for one-fifth of globally traded oil. This would likely push crude prices back to 2008's high of $147 a barrel."

Bank of Canada Governor Mark Carney noted this week that higher crude prices are generally "a net positive" for Canada's economy. But, he told The Canadian Press, "we're getting at the moment a little less of a positive uplift from higher oil prices than we would normally. And we're getting that drag on consumption from higher gas prices."

As Mr. Carney notes, high gas prices are eating into Canadian budgets, and what consumers can spend.

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Gasoline accounted for almost 4 per cent of the after-tax income of Canadian households in the last quarter of 2011, noted Adrienne Warren of Bank of Nova Scotia, which was within striking distance of the high set in mid-2008.

And the climb in prices in the past few months indicates that level could have hit a record in the first quarter of this year.

"We estimate that the roughly 15 cent-a-litre increase in average retail gasoline prices from their recent low of $1.15/litre in late December to around $1.30/litre at the end of March diverted over $1-billion from other more discretionary spending and/or household savings through the first quarter," she said.

"If gasoline prices were to move up further to $1.50/litre by June, this could shave another $1.5-billion from spending/savings in Q2, with a potentially even bigger impact entering the busy summer driving season."

Ms. Warren's colleague, Derek Holt of Scotia Capital, noted the "massive amount of capacity" sidelined at northeastern U.S. refineries because the economics don't work.

"Indeed, by next year, roughly half of the capacity that had been in place just before the global crisis hit will have been taken off line including the region's largest refinery later this summer," Mr. Holt said.

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"Gasoline prices at US$4 a gallon that are tied with the peak of last April and May could ultimately be looked back upon as cheap," he said in a report Thursday.

"If so, then the lagged effects on consumer spending could well be negative by late spring and into early summer and harsher than the hit to consumption in 2011Q2. Because job growth is only okay and credit access is still tight, consumers will pay more for what they have to by way of gasoline and food prices, and cut back on discretionary spending which is exactly what happened a year ago."

Then there are house prices BMO's Mr. Guatieri also took a look at real estate prices - he clearly knows the hot buttons - notably in Toronto.

Canada's housing market has been cooling overall, but economists remain concerned about Toronto and Vancouver.

In Toronto, sales are up 7.8 per cent from a year ago, and average prices up 10.5 per cent.

"Strong demand for, and tight supplies of, detached properties have lifted their median price to $540,000, greater than seven-times median family income and now higher than in the San Francisco metro area (after its price spiralled down from a pre-crash high of US$846,000)," Mr. Guatieri said in a report.

"Since the 2008 mini-correction, Toronto's house prices are up a mouth-watering (for owners) and eye-watering (for prospective buyers) 47 per cent," he added.

"While most of the country has followed the soft-landing playbook, Toronto appears to be tracking an entirely different script - one written back in the late 1980s. Hopefully for recent buyers, this story won't end as badly, as prices subsequently fell 28 per cent."

It's different this time, he noted, citing low interest rates, foreign demand and a slower pace of growth in real house prices than in the 1980s.

"This suggests today's boom is driven less by speculation and more by fundamentals (such as low interest rates, strong immigration and land restrictions). Nonetheless, that may only mean that prices won't fall as fast when the market reenters the atmosphere - as it will when at least one exhausted rocket engine (low rates) disengages."

Canada rules The Wall Street Journal is getting awfully warm and fuzzy where Canada is concerned.

Earlier this year, the venerable newspaper noted that Canada has become a "favoured destination for investors seeking refuge from the turmoil sweeping the euro zone and the continuing uncertainty over the U.S. fiscal position." It heralded our triple-A rating and the Canadian government's "sterling" fiscal standing.

Then this week, it published an article headlined "Canada Beats America," with this deck: "And we don't mean in hockey. Try taxes, spending and energy."

"Not too many years ago, Americans could get away with cracking jokes about spendthrift Canada, its weak dollar and the long wait for MRIs," the Journal wrote. "These days, the joke is on Americans, as Canada's government has cleaned up its fiscal mess and focused on private economic growth."

Those many years ago came in the mid-1990s, when the same newspaper referred to Canada as "an honorary member of the Third World" and its currency as the "northern peso."

Times have clearly changed, according to the Journal.

It cited Finance Minister Jim Flaherty's most recent budget, and his promise to erase the deficit by 2015 without tax hikes, Canada's "better policies" that dodged a housing meltdown and Ottawa's treatment of Canadian resources as "national assets to be exploited."

Euro troubles heighten As analyst Michael Hewson of CMC Markets puts it, "Europe remains a running sore and fears that the problems in the satellite countries are starting to infect the core of Europe are rising after economic data this week pointed to worries about both French and German economic activity."

Europe's troubles never went away, but they did flare up this week as the focus of the debt crisis was on Spain, where bond yields spiked, and to Greece, where the public suicide of a retiree became a symbol of what ails the country.

The debt crisis refuses to go away, while the economy of the 17-member euro zone continues to be bleak, as recent indicators suggest.

Unemployment is at intolerable levels in many countries, notably Greece and Spain.

In Greece, for example, one-fifth of the work force is unemployed, and half the country's young people are without jobs.

The pain in Greece, where the debt crisis and harsh bailout terms have led to severe austerity measures, highlighted by the suicide this week of Dimitris Christoulas, a 77-year-old retiree who shot himself near parliament, leaving a note that said his financial troubles were too great and that he'd rather die than hunt for food.

"This suicide highlights how painful and dramatic these cutbacks are for the Greek people," said political science professor Grant Amyot of Queen's University. "They are being forced to endure a massive cut in the standard of living."

In the markets Robert Kavcic of BMO Nesbitt Burns called it a "bull fight."

Dogged by the troubles in Spain and signals from the Federal Reserve that there's no more stimulus in the pipe, markets slipped. The S&P 500 shed 0.7 per cent, while Toronto's S&P/TSX composite lost 2.3 per cent.

Required reading this week A majority of Yellow Media Inc. creditors have begun to hash out a blueprint to take over the troubled phone-directory company, Steve Ladurantaye and Tim Kiladze report.

With beer sales declining in its key markets and most of the industry's big consolidation opportunities behind it, Molson Coors Brewing Co. (is reaching into Eastern Europe to expand its business, Sean Silcoff writes.

Almost two dozen life insurers are banding together to share the risk of claims for expensive drugs, as costly new treatments for illnesses such as cancer and auto-immune diseases become more common, Tara Perkins writes.

As Target prepares to invade Canada, suppliers are paying big bucks to learn about the U.S. discount retailer's tastes and tactics, Marina Strauss reports.

Barrie McKenna examines Canada's inefficient and politicized electricity business, which isn't just unfortunate, but costly, as well.

What to watch for next week There's a lot going on next week, from economic reports to the start of another earnings seasons.

In Canada, we'll get a look at how our exporters did in February when Statistics Canada reports the country's trade balance on Thursday morning. It's expected to be little changed from January's $2.1-billion, perhaps slightly less.

"Canada's trade surplus has been stayin' alive in recent months, dancing to the tune of a more upbeat U.S. trading partner," said Emanuella Enenajor of CIBC World Markets.

"Stateside demand likely supported Canada's exports again in February, with rising domestic auto production suggesting that vehicle shipments to the States may have done well," she said in a report.

"Other sectors of exports, however, may have struggled. Production disruptions at a large north Alberta oil sands producer saw crude oil output in February plunge, according to data from the National Energy Board. Associated exports may have also taken a hit. As well, falling natural gas prices and production could have contributed to the first decline in energy exports in four months."

In the United States, markets will get a fresh reading Friday on inflation, which is believed to have slowed in March to about 2.6 per cent or 2.7 per cent on an annual basis, from February's 2.9 per cent.

"Though retail gasoline prices continued to rise, the pace has slowed markedly in the face of some stabilization in crude oil prices," said Paul Ferley and Tom Porcelli of Royal Bank of Canada. "This is expected to result in the energy price component rising a more moderate 0.7 per cent in March."

In the markets, it may seem like earnings seasons never end. The latest is set to kick of as Alcoa Inc. reports its first-quarter results. Other companies scheduled to report include Google Inc., JPMorgan Chase & Co., Wells Fargo & Co., Astral Media Inc., Cogeco Inc. and Shaw Communications Inc.

"The Q1 earnings season unofficially gets under way next week when Alcoa reports on Tuesday, and the general theme will likely be one of much cooler profit growth," said BMO's Mr. Kavcic.

"S&P 500 earnings are currently expected to rise 3.2 per cent year over year in the quarter, down from 9.2 per cent year over year in 2011Q4 - that would be the slowest pace since 2009Q3 when the economy was pulling itself out of recession."

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More

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