Impact of Energy Prices in North America
In the second quarter of 2005, GDP growth slowed somewhat in the US and Canada. While output in the US expanded by nearly 3.6 per cent per annum, it marked the fourth consecutive quarter of decline in the headline growth rate. With the notable exception of private consumption growth, which accelerated to 3.8 per cent per annum in the second quarter, up from 3.5 per cent in the preceding quarter, all other components of domestic demand, including government consumption, business and housing investment recorded slower growth. In contrast, Canadian domestic demand continued to gain momentum and rose by 4.7 per cent on an annual basis in the second quarter of this year, with private consumption and business investment driving the expansion. However, Canada's exports rose by just 0.1 per cent in the second quarter relative to a year earlier, compared to a rise of 4.3 per cent in the preceding quarter. While import growth also slowed somewhat, this was not enough to offset the strong negative impact of stagnating exports on GDP. As a result, Canadian GDP expanded by 2.7 per cent on an annual basis in the second quarter of this year, down from the 3.2 per cent annual growth rate recorded in the first quarter.
As discussed in the latest Euroframe-EFN Report (2005), changing financial conditions, the persistence of high oil prices and the impact of hurricanes Katrina and Rita have led us to revise our forecast of US output growth down by about 0.4 percentage points for 2005 and 2006, while our forecast for Canada's GDP growth remains largely unchanged, with output expected to grow by about 2 3/4 per cent per annum. Although both central banks have continued to raise short-term interest rates, Canadian long-term interest rate fell to 3.8 per cent in the first half of this year, while US long rates remained broadly stable at 4.2 per cent.
High energy prices and robust demand for oil and natural gas are expected to continue to have opposing consequences on the US and Canadian trade balances. The latest monthly figures from Statistics Canada indicate that Canada's trade surplus in the twelve months to August reached its highest level on record. Energy products, mostly crude oil, petroleum and natural gas, now comprise 20 per cent of the value of Canadian exports. Given the impact of hurricanes on the US energy supply, we expect the Canadian trade surplus to continue to benefit from high energy prices and strong demand south of the border. Therefore, Canada's current account as a share of GDP is forecast to remain above 2 per cent this year and in 2006. High energy prices have the exact opposite impact on the US trade balance: in August, net imports of energy products accounted for 36 per cent of the US monthly trade deficit.
Hurricanes Katrina and Rita have caused severe disruptions to oil and natural gas production facilities in the Gulf of Mexico. This exacerbates the already short supply of oil refining capacity and intense pressure on US energy supplies. The risk of a cold winter points to further upward pressure on energy prices. This suggests that US retail energy prices will remain high and energy spending will constitute a larger portion of consumer spending this year. In 2004, US households spent about 5.5 per cent of total consumption on energy, with gasoline and natural gas accounting for about 1/2 and just under 1/4 per cent of energy spending, respectively. As of August, retail prices for natural gas were up 11.9 per cent as compared to the same time last year, on top of already high retail gasoline prices, which were 53 per cent higher in September of this year as compared to the same month in 2004.
Energy price surges in the late 1980s and 1990s tended to be transitory, so US consumers responded by temporary drops in savings rates. However, the current rise in energy prices started long before the latest hurricanes. It has been large enough and sustained enough to convince consumers that at least part of the increase in energy costs is permanent. …