Rising Price Of Oil Puts Increased Pressure On Ontario Economy

The price of oil set yet another record, breaking the $135 barrier on May 22, 2008. What’s more, growing supply concerns combined with growing demand for energy hungry China led Scotia Bank to forecast that these high prices are here to stay, at least through 2009. Scotia Bank is forecasting the price of crude oil to stay in the $135 to $140 range through 2009. The report attributes the rise in future price expectations to new supply constraints in Russia, as well as a number of other existing production capability constraints among other non-OPEC producers. The report also cites an expectation of growth in demand caused by high government subsidies shielding consumers in Asia, Middle East and Latin America from the extraordinary increase in gasoline prices.

Though high oil and energy prices bode well for the newly-emerged “have” provinces on the western and eastern spectrums of the country, any further increases in oil and energy prices could lead to prolonging the hardships endured here in Ontario. Prospects for Ontario’s economic growth have been repeatedly scaled back with every new published forecast. The latest consensus among financial institutions is that the province’s economy will remain adrift somewhere between 0.5 and one per cent growth through 2008, and only pick up steam in 2009 as the U.S. economy turns a corner and regains its appetite for Ontario’s manufactured goods. However, faced with the prospect of $140 per barrel (pb) oil, the next set of forecasts may push recovery even further on the horizon, as increases in the price of oil put added upward pressure on the Canadian dollar and exacerbate the already dismal economic situation in the U.S.

After settling as low as $0.97 at the end of March, the Loonie has again clawed its way back above parity with the U.S. If Scotia Bank forecast holds true, and the price of oil continues to climb, then the prospect of a slow retreat in the value of the Canadian Dollar, an expectation of many economists, may not come to pass as quickly as expected and thus prolong heightened competitive pressures on Ontario’s manufacturing sector.

Another consequence of higher oil prices is that they will put added inflationary pressures on the U.S. economy, thus limiting the Fed’s ability to stimulate the economy through further interest rate reductions. The U.S. Central Bank has already upped its expected inflation rate to over three per cent this year, one per cent above its previous forecast.

In contrast to the U.S., inflation in Canada has up until now been fairly tame, a combination of the run-up in the exchange rate between the Canadian and U.S. dollars and the recent one per cent cut into the federal sales tax have had a strong deflationary effect on prices. However, neither of these effects is long-lasting. The GST effect will run out at the end of the year and the recent decreases in the price of imports, caused by last year’s dramatic appreciation of the Canadian dollar are showing signs they may have run their course.

The overall annual inflation rate in Canada increased to 1.7 per cent from 1.4 per cent in March, the first increase since September 2007. Increase in the price of gasoline and baked goods were the leading causes for the increase and, although vehicle prices eased on April, down 6.6 per cent compared to April 2007, the decrease was not as aggressive as the 7.1 per cent recorded in March, thus causing an additional upward pressure on inflation.

Core inflation (inflation excluding the volatile prices of energy and select food items) also edged up in April increasing to 1.5 per cent from 1.3 per cent in March. Although Canada is still in much better shape relative to other western economies, the unexpectedly strong increase in inflation may be a sign that the shielding effects of the strong Canadian dollar may have run out. However, inflation is still well under the Bank of Canada’s target rate of two per cent, thus leaving room to cut rates for a fifth straight time at its Jun. 10 meeting. However, increases in the rate of inflation raises speculation as to whether the cut will be as sizable as the 50 basis points cut in both March and April, and also makes the prospect of any future cuts much more uncertain.