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TORONTO, July 9, 2008 – The received wisdom in recent years that the Canadian economy benefits on balance from higher oil prices, given the country's status as a significant (and growing) net energy exporter, is in serious need of review, according to a new report from Douglas Porter, Deputy Chief Economist, BMO Capital Markets.

“There is a strong case to be made that the surge in oil and gas prices crossed the tipping point this spring from providing some economic ballast for the domestic economy to acting as a heavy anchor,” said Porter. “Even at a time when the trade surplus on energy goods has reached an all-time high of nearly 5 per cent of GDP, the negative hit on the prospects of Canada's major trading partners and consumers looms much larger.

“Some sustained moderation in oil and gas prices would be the most positive near-term development possible for the greater good of the Canadian economy at this stage,” he stated.

Porter notes three channels where higher energy prices become too much of a good thing:

• Industry: The surge in energy costs is first and foremost a problem for domestic industry, since it raises costs across the board and hammers growth prospects in the industrialized world. “Even the oil and gas sector has been unable to make much of a contribution to real output growth in recent years,” according to Porter. “Its share of GDP has actually dropped significantly from its peak in the mid-90s amid fading production of conventional oil & gas and despite rising oil sands output.” Meanwhile, the latest charge in gasoline prices has taken direct aim at U.S. auto sales, which has hit Canadian industry hard.
• Consumers: The energy price spike has also landed a direct hit on Canadian consumer sentiment and wallets. While sentiment is still somewhat healthier than in the U.S., thanks to solid real wage gains and a much stronger job market in Canada, the sag in domestic confidence has also put a chill into the housing market. Plus, while raging gasoline prices have been hogging the headlines, natural gas has been quietly rising every bit as fast as crude oil in the past year (doubling in that period), and this will wallop household heating bills this winter. With many of the energy input costs for hydro companies on the march, it is only a matter of time before electricity prices also lurch higher in many provinces. Accordingly, total spending by Canadian households on energy likely hit an all-time high as a share of disposable income in the second quarter of about 7 per cent and looks poised to continue heading higher.
• Inflation: The dramatic sprint in energy costs is also finally making an important impact on Canadian headline inflation. After largely sheltering Canadians from global inflation forces for years, the latest Bank of Canada Business Outlook Survey revealed that companies are now preparing to ramp up prices, and many expect inflation to stay above target. The CPI report for June, due later this month, could hit the 3 per cent barrier, and threatens to push above the top end of the Bank of Canada's comfort range in the next few months. Also, these figures are still flattered by the 1-point GST cut at the start of the year, meaning the underlying inflation rate will be closer to 3.5 per cent.

The complete report can be found at www.bmocm.com/economics.

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