As oil prices soar, the value of the Canadian dollar has become less closely tied to global oil prices, giving the Bank of Canada a bigger role in dictating the loonie’s future, a report from CIBC World Markets says.
Despite a huge run-up in the price of oil amid the ongoing conflict in Ukraine, the Canadian dollar hasn’t moved much, the report noted.
“The loonie sits close to where it stood in early 2021, when [crude oil] prices were running in the low US$50 per barrel range,” it said.
Listen to this Soundbites episode, featuring Aylon Ben-Shlomo of Aristotle Capital Management.
The report suggests one reason is that capital spending in the energy sector has declined since 2014 and now plays a smaller role in overall GDP than in the past, weakening the link between oil prices and economic growth.
“That could reflect several forces, including environmental policies that are seen as increasing hurdles for mega-project approvals, investor reluctance to back energy sector projects, expectations that lofty oil prices could prove temporary, and a generally more cautious approach to capital spending across the sector,” the report noted.
Regardless of the underlying cause, the result is that the economy won’t benefit as much as it has in the past from sky-high oil prices.
At the same time, data suggests that the market “no longer looks at oil prices as a factor in relative interest rates between the U.S. and Canada,” the report said.
Indeed, CIBC said it continues to expect rate hikes from both the Bank of Canada and the U.S. Federal Reserve this year, with the loonie weakening modestly as a result.
“Neither the Ukraine conflict nor some upside surprises in inflation have seen us alter the 100 basis points we expect from both the Fed and the Bank of Canada this year, with a further leg in store for the subsequent two years,” it said.
Additionally, the economists boosted their inflation forecasts on the basis that higher oil prices won’t drive a disinflationary rise in the Canadian dollar, but their overall GDP forecast for Canada hasn’t changed.
“Russia’s invasion will have downside implications for European growth, and by extension global growth, but as a commodities exporter, Canada will see some offset from at least a risk premium lingering for a while in prices for fossil fuels, grains, fertilizers and some metals,” it said.
For the U.S., however, CIBC trimmed its 2022 GDP forecast by 0.2% and boosted its inflation call by nearly 2%.