January 13, 2015 / 7:38 PM / 3 years ago

UPDATE 2-Bank of Canada: cheap oil bad but effect not drastic

(Adds remark on oil price effect on growth not being drastic, analyst quote on implication for interest rates)

By Brendan O'Brien

MADISON, Wisconsin, Jan 13 (Reuters) - The collapse in crude oil prices may delay the Canadian economy's return to its production potential but is unlikely to have a drastic effect on growth, Bank of Canada Deputy Governor Timothy Lane said on Tuesday.

While he stopped short of saying crude's plunge could delay interest rates hikes, Lane made clear the central bank's view that cheap oil was bad for the economy despite mitigating factors.

Any Canadian gains from lower prices for consumers and stronger global growth would be more than reversed over time as the impact of lower oil industry incomes spreads through the economy.

"We see important risks to Canada's economic outlook stemming from the recent decline in the price of oil and other commodities," Lane said in a speech to a business group.

Pressed in a question-and-answer session afterwards, he noted that Bank of Canada Governor Stephen Poloz had estimated in December that cheap oil would take 1/3 of a percentage point off growth this year.

The bank has been working further on quantifying the countervailing effects, and will also take into account a further $20 a barrel fall in oil, when it puts out its quarterly Monetary Policy Report next week.

Lane declined to give a number but said "we're not thinking of something that's drastic."

After being the first Group of Seven industrial nation to hike rates, in 2010, after the global financial crisis, the central bank has kept rates at 1 percent, and markets do not expect it to raise rates until the fourth quarter.

Central banks around the world, the Bank of Canada included, will "look through" or ignore the immediate and temporary drop in overall inflation caused directly by cheaper oil, Lane said.

Beyond the immediate impact on inflation, the Bank of Canada "will closely monitor its broader impacts on growth and the delay it may cause to the economy's return to its production potential," he said.

Analysts said the speech reinforces dovish expectations for the policy statement next week.

"With core inflation serving as the operational guide for the conduct of monetary policy, a slower move to full capacity versus a collapse in activity speaks at present to a more patient central bank than our current expectation for the an October 2015 hike but not one that is considering a cut in the overnight rate," said David Tulk at TD Securities.

Lane gave a bearish prognosis for oil prices, saying they "could go lower, or remain low, for a significant period" before medium-term forces push them up.

Expectations that low prices will persist will significantly discourage oil investment and exploration. Lane noted signs this is happening already. (Writing by Randall Palmer and Leah Schnurr in Ottawa; Editing by Peter Galloway and Nick Zieminski)

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