Canada: Oil Price Drop Weighs on Growth

Growth solid but unbalanced

Low oil prices weigh on growth, as energy investment suffers

Monetary policy accommodation, neutral federal fiscal stance appropriate

The economy has been expanding at an above-potential rate since 2013, with a growth rate of 2.4 percent last year. The awaited pickup in exports, driven by a stronger U.S. recovery and a depreciating Canadian dollar, is encouraging. But rebalancing of growth away from private consumption and housing remains incomplete. Shifting the composition of growth toward exports and investment would generate a broader, more durable recovery, the report said.

In terms of key domestic risks, household debt has stabilized, but is still high. Housing markets remain strong, with estimated house price overvaluation ranging between 7–20 percent, but with large differences across regions and markets.

Growth is expected to edge down slightly in 2015—to 2.3 percent—mainly because of the significant drop in oil prices, which hurts investment in the oil sector, but will be offset in part by the weaker loonie and stronger U.S. growth. Risks to the outlook have increased, given sluggish global growth, still-unfolding effects from lower oil prices, and housing market risks.

Effects of lower oil prices

Canada is a net energy exporter, where the energy sector plays an important role in the economy, accounting for about 10 percent of GDP, a quarter of exports, and a quarter of non-housing private investment. A persistent and large decline in oil prices is expected to dampen Canada’s growth, mainly through weaker investment in the energy sector, although the impact on oil production may be more muted given existing capacity and growing market share in the United States.

On the upside, lower oil prices are expected to benefit consumers and non-energy sectors, especially in the context of a weaker currency and stronger U.S. growth. Lower oil prices will contribute to the necessary rebalancing of the economy also through the cooling impact on the most overheated housing markets. With the main engine of Canada’s recent growth—the energy sector—taking the hit, the economy’s ability to overcome longer-standing weaknesses in the non-energy sector by boosting its productivity will be increasingly important.

Continue monetary policy support

In the wake of significantly lower oil prices and increased uncertainty around an otherwise solid economic outlook, the Bank of Canada cut its policy rate by 25 basis points...