Bank of Canada Preview: Look Here Not There

Economists have spilled plenty of ink debating the economic impacts of higher oil prices. For Canada, the national‑level implications are relatively straightforward. If sustained, higher oil prices represent a positive terms‑of‑trade shock, lifting both economic output and inflation. Our team quantified these effects in a timely note External link. last week.

The Bank of Canada’s reaction function to higher energy prices is also fairly simple. Even in a world where central banks are more sensitive to supply shocks, the Governing Council retains substantial flexibility to remain patient. Policymakers will generally look through an oil price shock unless inflation expectations become unanchored, underlying inflation reaccelerates or the output gap closes meaningfully.

At this stage, it’s far too early for central bankers to conclude that any of those conditions are materializing, particularly with the sharp deterioration in labour market conditions this year. As a result, it should come as no surprise that the Bank of Canada will hold rates steady next week, reiterating that the current level of rates remains appropriate. Officials will likely just layer on a reference to upside inflation risks from higher global energy prices.

Even if oil prices remain elevated, serious conversations about rate hikes shouldn’t gain much traction in the near term. Instead, attention should remain focused on key downside risks to the economy—most notably those tied to the labour market and housing.

Central bankers have largely sidestepped any detailed discussion of residential real estate, characterizing the housing market as simply subdued and uneven across regions. But the data in several of Canada’s largest cities are clearly deteriorating, and higher oil prices risk compounding those pressures.

While higher oil prices will support growth in Alberta, Saskatchewan, and Newfoundland and Labrador, they will weigh on activity in provinces such as British Columbia, Ontario and Quebec. Housing markets in Montreal, Saskatoon, Regina and St. John’s have proven resilient and aren’t in need of support. Calgary and Edmonton have softened more recently and will welcome any lift from a stronger resource sector. But the areas most in need of support lie elsewhere. Housing markets in Toronto, Vancouver and many surrounding regions are firmly in recession.

Rising oil prices, which have pushed benchmark interest rates higher, could amplify those headwinds. Mortgage rates are set to increase just as a tidal wave of homeowners face renewal. The most vulnerable are those with variable‑rate, fixed‑payment mortgages, some of whom could see payment increases of 70% or more. While the share of residential mortgages in arrears is just slightly above the pre‑COVID average, the numbers have been trending consistently higher. In Ontario, arrears rates haven’t been this high since early 2012, and the province now accounts for more than half of all arrears.

With hopes that improved seasonal dynamics will bring some relief to Canada’s hardest‑hit housing markets, we’ll be watching real estate conditions closely in the months ahead. On their own, housing market strains could argue for additional monetary stimulus, causing markets to at least rethink the likelihood that rate hikes will arrive before the end of the year.

But if Canada is undergoing a more structural shift that lowers potential growth—similar to how Governor Macklem has described the evolving trade relationship with the US—then the neutral rate of interest may ultimately be lower than the Bank of Canada’s current estimate. In contrast to the central bank’s recent claim, that would mean that the current policy rate setting isn’t stimulative at all. But since policymakers won’t revisit their neutral rate estimate until April, expect them to dodge questions on that topic too.