Continued instability in the Middle East and North Africa has seen a rise in oil prices over recent weeks. Will this likely be a significant factor for long-term global growth prospects?
History suggests not
So far the scale of the current oil price shock is relatively small in comparison to the other rises since WW2. Although over the past 8-months, oil prices have risen by 50%, this pales in comparison to the 240% rise over a few weeks in 1973/34, 150% over six months in 1978/79 and 100% over a year in 2007/08 to name a few.
US inflation starting to show signs of impact
As a general rule, oil prices tend to cause economic damage to the US economy when US crude increases above $95-$100 per barrel.
- A sustained $10 rise in the oil price will normally lower US growth by about 0.2% in each of the following two years.
But a February 2011 survey conducted by the Wall St Journal showed that economists believe oil prices would have to trade above $125 per barrel “to threaten the US recovery”.
With the current price at around $105 per barrel, the University of Michigan’s March index of consumer confidence indicated the first real impact to the US economy.
- The index collapsed from February’s 77.5 to 67.5 – a six-month low.
- Expectations of inflation for the next year rose to 4.6% from the previous month’s 3.4%.
Although the CPI-linked US treasury market isn’t revealing the same rise in inflationary expectations, the Federal Open Market Committee (FMOC) is very focused on both core inflationary pressures and inflationary expectations, so this latest report is likely to cause some concern.
It does not look like this will trigger a normalisation of monetary policy yet, but if these inflationary expectations become reality as the year progresses, concern will mount at the Federal Reserve.
Containing the spillage
The hardest areas hit by rising oil prices are the Non-OPEC developing economies, as incomes are lower and oil makes up a far larger proportion of total consumption.
Oil consumption as a % of 2009 GDP
- 9.5% in Egypt
- 9.2% in Thailand
- 6.4% in India
- 3.3% in the US
- 2.2% in Japan
In turn, rapid oil price increases will have a very deflationary impact on the economies of the Non-OPEC developing world, as consumers will be forced to abstain from non-essential purchases.
Who would want to be a central banker?
These somewhat unpredictable oil price increases create a rather nasty dilemma for the world’s central bankers.
- They are inflationary if caused by robust global economic growth.
- They are deflationary if caused by a supply crunch that acts as a tax on oil consuming nations.
Intriguingly, the current situation not only contains elements of both, but there is also have the added twist of a flood of global liquidity courtesy of the Federal Reserve’s second round of quantitative easing – with money leaking out of the system and playing havoc with global commodity prices.
Central banks are carefully monitoring inflation and some have already taken action
- The US Federal Reserve and the Bank of England both believe headline inflation (CPI) will return to the lesser core (ex-food & fuel) measure as time progresses.
- The European Central Bank looks like they will increase interest rates at their scheduled April meeting as a response to headline inflation.
- Both the Indian and Chinese central banks have embarked on monetary tightening initiatives (be they rate hikes, increases in reserve requirements, or tightened credit to specific sectors) as a direct response to mounting inflationary concerns.
Is there a need for drastic action?
- At present it does not look like that the threat of a double-dip recession is a realistic possibility. Oil prices would have to be much higher, at around $150 per barrel to really threaten the current global recovery or trigger a potential double-dip.
- Having learned the lessons of the 1970s stagflationary era – the world is considerably less dependent upon oil than it was. The ratio of oil consumption to world GDP is running at some 60% of the levels experienced in the 1970s.
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