The near-60% drop in oil prices continues to rock the global economy and financial markets, adding to deflationary pressures that were being driven by weak demand (especially in Europe and Japan, and emerging in China). As a result, central banks around the world are suddenly cutting interest rates or easing monetary policy in more controversial ways.
Canada joined the club overnight, following Denmark on Monday. The Turkish central bank cut rates earlier this week as well. The Swiss National Bank cut its key rates to negative levels as part of the controversial unpegging of the Swiss franc from the euro late last week, and the minutes of the last monetary policy committee meeting of the Bank of England show that the two members of the monetary policy committee who had been demanding a rate rise last year had changed tack and now support the “no change” stance set at the January meeting. Plunging oil prices and the spectre of deflation are game changers, even for the most rigid of austerians among economists, as well as those in business and government.
In Tokyo, the Bank of Japan eased one of its monetary-easing policies at its meeting yesterday to try to boost bank lending amid cuts to its inflation forecasts and the tacit admission that the controversial policies it adopted last year have failed to boost inflation and break deflation’s grip on the economy. And tonight, the European Central Bank will reveal plans to buy a reported 50 to 60 billion euros’ worth of securities per month in a major expansion of its quantitative easing to try and stave off the onset of deflation.
And Australia? Well, Westpac stamped its tiny foot yesterday and demanded the Reserve Bank cut interest rates at its first meeting of the year, scheduled for next month. But the AMP chief economist Dr Shane Oliver isn’t as insistent (his company doesn’t have a multibillion-dollar interest-rate-sensitive balance sheet) and doesn’t predict a cut next month, but a little later in the year.
But despite suffering the repeated whammies of falling prices for iron ore, coal of all types, and now oil and gas prices, the Australian economy remains in reasonable shape, thanks to the home-building boom, reasonable consumption spending and modest jobs growth. Our cash rate is already at an all-time low of 2.5%, and next Wednesday’s CPI for the December quarter will contain figures showing a further slide in the cost of living, led by lower petrol prices. But petrol prices have fallen further this month (to under $1 a litre), so weak CPI for the March quarter already seems on the cards.
On the face of it, that will allow the RBA to cut its key rate, but the central bank is suspicious of sharp falls and rises in volatile products (such as energy costs) and “looks through” them until it becomes convinced that the price changes are embedded. That’s why if there is a rate cut next month, it will be because the bank has become convinced low energy prices are here to stay, and if there’s no rate cut, the bank remains uncertain as to the longevity of low oil prices. A quick rate cut could push the Aussie dollar under US80 cents, but here the RBA will want to see the impact on markets of the ECB’s expansion of its spending program and what it does to the value of the dollar.
The ECB has been staggering fitfully towards an expansion of its already adventurous monetary easing (cheap four-year loans for banks, buying short term government securities), fighting off German attempts to stop the ECB, or limit its ability to buy securities. But the plunge in oil prices is now directly pushing more and more of the eurozone (and the rest of Europe) towards deflation. At the moment, much of the area is in the last throes of disinflation (inflation falling and being wrung out of the system). Some economies — such as Italy, Greece, the Netherlands and Denmark — are feeling the early grip of deflation, or are firmly in its grasp. Sweden, the UK, France, Germany, Spain and Austria are all facing similar pressures.
But the most significant oil-price-related move by a central bank came overnight when the Bank of Canada surprised with a cut of 0.25 percentage points to its key lending rate, which had remained at 1% since September, 2010. Canada is a net exporter of oil (mostly to the United States) and the near-60% slide in oil prices is threatening the viability of, as well as future investment in, the country’s oil-sands industry. In its statement, the central bank said it now expected the economy to grow 2.1% this year, down from its previous forecast of 2.4%.
And a report issued in Canada overnight laid out the main danger to the economy from the slide in oil prices — a severe fall in investment, especially in the energy industry in the west of the country. The Canadian Association of Petroleum Producers forecast capital spending in the industry in western Canada, including the oil sands (aka tar sands) of Alberta, will drop by 33% this year to CAD46 billion, from CAD69 billion last year. The association sees investment in “conventional” oil and gas in western Canada, outside the oil sands, to drop by 42% this year to CAD21 billion (Woodside is buying into a big LNG project in British Columbia, which now may be delayed), with investment in the oil sands to sliding 24% to CAD245 billion.
But as the Financial Times and Canadian papers pointed out, these cuts won’t impact oil production, with an estimated 300,000 extra barrels of output coming on stream this year and next because current projects are too far advanced to stop. In other words, the Canadian oil sector, especially its much-vaunted oil sands industry, will continue to sow the seeds of further price falls and cuts to investment and employment for the next two years. That’s very different to south of the border in the US shale oil and gas sector, where rig use is falling fast, jobs are being lost and tens of billions of dollars of spending being cut — as BHP Billiton revealed yesterday with plans to cut its exploration spending this financial year by 20%, and to cut its rig numbers 40% in the next five months, including stopping exploration and development work on most of its shale gas fields.