This is no ordinary oil shock — it's much worse

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Create an account or sign in to continue with your reading experience. Access articles from across Canada with one account Share your thoughts and join the conversation in the comments Enjoy additional articles per month Get email updates from your favourite authors Sign In or Create an Account or This is no ordinary energy shock. Predictably, the Iran war has driven up the price of oil , but what is not typical, economists say, are soaring diesel prices which have climbed far beyond what a move in crude would normally imply.

“This is no longer just an oil shock,” said Olivier Gervais, director of modelling and forecasting at Scotiabank Economics, in a report this week. Historically refined products like diesel move with crude oil, but usually by less, he said. This episode, however, looks quite different, and adds a “distinct and broader layer” of inflation pressure.

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We encountered an issue signing you up. Please try again The price of refined products has been pushed higher than oil this year because of challenges in transporting the products through the Middle East and because the Ukraine conflict has shut down some of Russia’s refining capacity. “These two events combined led to a crunch in the supply of diesel in the global market and sent prices higher,” said Gervais.

To determine the impact of this additional shock, Scotiabank isolated the diesel price movements that could not be explained by crude oil and tracked their impact through consumer and producer prices. “We find clear evidence that the inflationary effects extend beyond energy in both Canada and the United States,” said Gervais. The economists calculate that a temporary increase of about 15 per cent in the diesel spread close to what we are seeing now would raise consumer price index inflation in Canada by 0.6 percentage points and by 0.8 points in the U.S.

This pass-through is not limited to headline inflation, but shows up in underlying measures as well. “When diesel prices rise independently of crude oil, the impact does not stop at the pump; it leads to broader price pressures later on,” said Gervais. The pass-through is gradual and persistent, said the report.

Because diesel is critical to trucking, agriculture, construction and manufacturing, higher fuel costs spread through freight, production and distribution networks before reaching consumer prices. Transportation prices are the first to rise, followed by food, shelter and other categories a year to 18 months later as higher costs work their way through the supply chain. A separate study by Oxford Economics found evidence that U.S. trucking companies are already passing part of the fuel shock onto customers.

Neither are major crude producers with domestic refineries protected as oil and refined products trade in global markets that set the prices. “Even large producers such as the U.S. and Canada remain exposed to higher global crude and diesel prices despite having greater domestic supply security than major importers,” said Oxford. Scotiabank warns that if the energy shock persists it will become far more dangerous.

“Product-price shocks are usually short-lived, so that risk should not be overstated,” said Gervais. “But the longer the shock endures, the greater the likelihood that firms pass on higher costs more forcefully, inflation expectations become more sensitive and monetary policy is forced to respond more aggressively.” The Bank of Canada and the Federal Reserve would be willing to look through a temporary price shock, but if it spreads to broader inflation expectations, they would be forced to hike interest rates higher. “With upside risks beginning to accumulate, this new shock adds fuel to the fire,” said Gervais.

Sign up here to get Posthaste delivered straight to your inbox. With bond yields climbing around the globe, Toronto Dominion Bank has revised its forecast from June to reflect that Canadian bonds are not immune to the recent rise and that forces driving the climb in rates are set to linger. TD says these higher yields, which underpin fixed mortgage rates, are already likely impacting the housing market with sales declining for the first time in six months in August.

The bank has downgraded its forecast for growth in home sales and prices and now expects sales to decline five per cent this year and prices to stay flat. Today’s Data: Canada and United States trade readings Earnings: Constellation Brands Inc. One of the most dangerous signals in investing is when market indexes tell a very different story from the underlying data, writes investing pro Martin Pelletier.

Today, the S&P 500 sits near record highs, suggesting investors remain optimistic about economic growth, corporate profits and the future. Yet beneath the surface, the average stock is struggling. Market leadership has narrowed dramatically, participation is deteriorating and an increasing number of companies are already in bear market territory.

The lesson is simple: when markets become dependent on a single narrative, investors should pay close attention to what is happening beneath the surface. Read his column here. Interested in energy?

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Visit the Financial Post’s YouTube channel for interviews with Canada’s leading experts in business, economics, housing, the energy sector and more. Today’s Posthaste was written by Pamela Heaven with additional reporting from Financial Post staff and Bloomberg. Have a story idea, pitch, embargoed report, or a suggestion for this newsletter?

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Source: Financial Post