Could $100 Oil Spike Mortgage Rates?

Inflation is at a 2.5% pace, a 4-year high.  Stats Can says mortgage costs are the main culprit.

Now the Bank of Canada may have another inflation worry:  oil.  CIBC World Markets predicts oil will hit $100 a barrel by 2009. 

It may sound alarmist but, if CIBC is right, it could take more than one or two more rate hikes to control inflation.

Comments

[Brian Poncelet]

The odds of the interest rates going much higher (.75% more) are slim. During the 70's in the US and Canada unions asked for and got higher wages. Unions in the US in the early 70's were about 30% of the work force. Today it is about 6%. Unions at airlines, Ford, GM etc. are giving up wages etc.

What does this mean? CIBC reports the quality of jobs is going down over time. So as people fill up their cars, buy food, other things will have to slow down, like the price of houses. Just a thought.

Brian Poncelt, CFP

[Online Mortgage Broker]

Hi Brian, It will be interesting to watch. As you note, manufacturing (and it's labour force) is a small component of Canada's economy these days.

However, housing is on fire and oil is used in everything (cars, commercial transportation, plastics, etc). If oil does leap another 33% to $100 I'd be shocked if inflation didn't jump too. With the Bank of Canada so fixed to its target 2% inflation rate, it's hard to imagine they wouldn't act agressively.

Have an excellent day,
Rob

[Brian Poncelet]

Hi Rob,

Yes you could be right the BOC could raise rates...but watch how new car sales, house prices fall, and retail sales fall etc. With in short time the country would be an recession. Remember, house prices etc., are backed by the highest debt levels in history! Remove the juice and the party ends!

regards,

Brian

[Brian Poncelet, CFP]

Hi Rob,

I thought I would follow-up on the $100 oil and interest rates. We hit $100 (it's now down to about $96) but interest rates have gone down!

Why? As enegery prices go up inflation does go up but wages are not. So the economy slows, and inflation does not look as bad as a slowing economy.

If any one remembers the 1970's oil went up and wages went up as well. Now you have high energy prices but very modest wage increases. If wages go up in a big way then I think we have problems (omitting Alberta of course).

If I was smart I'd be in the Bahamas for six months of the year!

regards,

Brian

[Al R]

Would check your assumption again - the latest StatsCan Labour Force Survey shows that growth in average hourly wages in November was up 4.2% over the previous year, which is well above CPI.

Canada has been relatively sheltered from higher oil prices by our historically high dollar, more than anything else. It's also kept prices of other imports down, which keeps inflation lower than it would otherwise be.

[Brian Poncelet, CFP]

Hi Al,

Take a look at Ststistics Canada web site. Nov. 2007 "Fuelled by higher gasoline prices...consumer prices increased by 2.5% between Nov. 2006 and Nov. 2007."

"Gasoline has been the dominant factor in the annual growth in all-items index since Sept."

"Gasoline prices were 17.6% higher in Novemeber 2007 compared to the same month in 2006"...guess what, wages are not keeping up with energy prices!

The high dollar helps but does totally protect. Example Jan 2007 oil was about $61 now is is around $96 even with about a 20% appreciation on the Loonie there is still a short fall.

When the CPI numbers which exclude energy the CPI numbers or "inflation" is usually much lower than with energy. Energy from Nov. 2006 to Nov. 2007 was up 10.3% Vs. the CPI "basket" or core CPI of 1.6%! (See CPI below)

The CPI (consumer Prices Index) is a fixed "basket" of things the "typical" Canadian consumer buys evry month, so if you bought a laptop or car, prices have gone down, but how often do you buy these things? Without energy the CPI has actually fallen lately.

As we pay more for gas, shipping etc. Less is spent elsewhere. Bottom line is I think interest rates are not going any higher for at least a year and we may see interest rate cuts first.

regards,

Brian

[Al R]

I may have misread your original post. My point is that even though growth in energy prices has outpaced wage growth over the past few years, wages are still growing at a rate above CPI, and are therefore contributing to (not taking away from) inflationary pressures.

Core inflation may be low, but using it as a measure (as the BoC does) and omitting volatile items like mortgage costs, some foods, and oil products doesn't mean that almost everyone isn't feeling the effects of higher prices in these areas.

Having said all that, I'm all for lower interest rates, but the Bank has to be careful that it doesn't get overenthusiastic. They've shown themselves to be highly competent so far, so I think we're in good hands.

[Brian Poncelet, CFP]

Hi Al,

If you want to look into the future look at Japan. In the 1980's real estate was very high. Banks and businesses were leveraged on (real estate) have fallen. In order to get things going again the Bank of Japan cut their bank rate to a current rate of about .5%. Once you hit those levels, cutting interest rates has almost no effect on the economy. The biggest problem believe it or not, is falling prices...only time will find a bottom, then no interest rate cuts helps, banks tighen up on their lending and unemployment goes up.

Every one says the US may have a "soft landing". Maybe they are right. But with record debt levels for consumers and the US governments I think the bad news is like the tsunami. While it looks not so bad in the ocean when it comes closer its too late to run. I think that the high energy prices, may be the straw that "breaks the camel's back".

regards,

Brian

[Brian Poncelet, CFP]

Hi MT,

Well we hit $100 oil. Interest rates are going down. The big news is US. housing prices are going down fast. I think this may take years before they hit bottom.

Where does this leave us in Canada? If I was smart I would be some where warm right now. But paying down debt and investing is a great idea for most Canadians.

regards,

Brian

[Brian Poncelet, CFP]

Hi MT,

Well we hit $114 per barrel of oil today. I think when this summer comes interest rates will be going down...but who cares if we are paying a $1.50 per liter!

The other story is natural gas, the prices have climbed 430% since 2000 and March (2008) was the largest increase (up 4.2%) in 33 years! Heating homes this winter will be painful, come bill time.

Who needs any interest rate increases to slow the economy, when the high prices of oil and gas will do this for us?

regards,

Brian

[Canadian Mortgage]

Hi Brian! You've been right so far. Kudos on that. It will be interesting to see if/when all these petroleum increases will filter through the economy and adversely impact Canada's CPI. The credit markets seem to be getting "nervous."

Cheers,
Rob

[Brian Poncelet, CFP]

Hi Rob,

In my world there is lots of talk about how the US recession will not really hurt us in Canada. They could be right, but even in Alberta people drive cars and heat their homes. This means less money to buy bigger houses, cars you name it.

Martin Feldstein was in Toronto last week giving a talk about the US economy. He was president Regan's cheif economic advisor. He was suggesting that this time the US recession will probably last longer than the 8-9 months of down turn we saw in 2001 or 2003. This "may be the longest down turn in fifty years"! He said he could be wrong, but the housing market is now the worst since the 1930's in terms of declines in home prices.

Who knows...

regards,

Brian

[Brian Poncelet, CFP]

Hi Guys,

So oil is now $126 a barrel! Here in Oakville, it is $1.24 per litre. My guess is this summer there is still more pain...so interest rates are not going anywhere for a long time. (I could be wrong)

The untold story is natural gas which has almost doubled since January! Which means heating costs for the winter should be almost double! The good news is real estate in the US is getting cheaper by the week.

regards,

Brian