Canada’s recovery at risk in ‘twilight zone’ of low oil and rising loonie

Following the recent crude oil price rally, economists say Canada’s economy risks getting caught in a bind where oil prices are not quite sufficient however the loonie is not very reasonable enough.

Canada’s dollar has already established a strong rebound in the past month, rising from about 68 cents from the U.S. dollar to 76 cents by Monday. Oil prices also have rebounded nearly Half in that time.

The Canadian economy has been feeling pressure of low oil prices for 2 years now, causing recession in provinces such as Alberta and mass layoffs in the energy sector. But recent data suggests that oil’s pain has been the manufacturing sector’s gain, as cheaper gasoline prices along with a weak loonie have helped the country’s non-energy industry’s be profitable.

Unfortunately, the current moves in oil and also the loonie could halt that shift.

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“Only recently are we began to see some positive signs originating from non-energy investment and production as corporate Canada began to response to the dollar depreciation,” said Benjamin Tal, deputy chief economist at CIBC World Markets. “This fragile recovery may be in danger as higher oil prices result in a stronger loonie. To put it simply, we suffer the pain sensation of a higher dollar without the gain of rising oil prices.”

Oil prices have rallied from slightly below US$30 at their low this season to more than $40 by Monday, but Tal notes the price gain isn’t enough to create a meaningful impact on Canada’s energy sector. A lot of companies will not even consider increasing capital spending or hiring unless prices move significantly higher.

At the same time, increases within the loonie could have very real impacts on investment and job creation for manufacturing firms. Canada’s manufacturers have been burned through the loonie before, especially in the years following a economic crisis, where the loonie crashed from parity using the U.S. dollar down to below 80 cents – only to rebound to parity two years later.

“The 6-cent appreciation within the worth of the dollar can make a difference in the decision making process for many (or many) manufacturing firms,” said Tal.

The developments leave Canada’s economy at risk of getting stuck within an “oil twilight zone” until oil prices either rebound to a level where energy firms start spending again or manufacturers and exporters visit a clearer sign the loonie won’t be moving much higher.

That will make for an interesting Bank of Canada rate announcement next month. It is likely Governor Stephen Poloz includes comments about the loonie whether it stays only at that level or moves even higher prior to the April 13 meeting.