Oil price slide – easy come, easy go?

July 3, 2012

One of the very few positives for the world economy over the second quarter — or at least for the majority of the world that imports oil — has been an almost $40 per barrel plunge in the spot price of Brent crude. As the euro zone crisis, yet another soft patch stateside and a worryingly steep slowdown in the BRICs all combined to pull the demand rug from under the energy markets, the traditional stabilising effects of oil returned to the fray. So much so that by the last week in June, the annual drop in oil prices was a whopping 20%. Apart from putting more money in household and business purses by directly lowering fuel bills and eventually the cost of products with high energy inputs, the drop in oil prices should have a significant impact on headline consumer inflation rates that are already falling well below danger rates seen last year. And for central banks around the world desperate to ease monetary policy and print money again to offset the ravages of deleveraging banks, this is a major relief and will amount to a green light for many — not least the European Central Bank which is now widely expected to cut interest rates again this Thursday.

Of course, disinflation and not deflation is what everyone wants. The latter would disastrous for still highly indebted western economies and would further reinforce comparisons with Japan’s 20 year funk. But on the assumption “Helicopter” Ben Bernanke at the U.S. Federal Reserve and his G20 counterparts are still as committed to fighting deflation at all costs, we can assume more easing is the pipeline — certainly if oil prices continue to oblige.  Latest data for May from the OECD give a good aggregate view across major economies. Annual inflation in the OECD area slowed to 2.1% in the year to May 2012, compared with 2.5% in the year to April 2012 – the lowest rate since January 2011. While this was heavily influenced by oil and food price drops, core prices also dipped below 2% to 1.9% in May.

JP Morgan economists Joseph Lupton and David Hensley, meantime, say their measure of global inflation is set to move below their global central bank target of 2.6% (which they aggregate across 26 countries)  for the first time since September 2010.

After peaking at 3.9%oya in September 2011, global inflation is expected to dip to 2.4%oya this month. If our top-down model is correct, global consumer price inflation could slide to just 2.1% by
year-end, 0.5%-pt lower than both our forecast and central bank targets. The risks are most skewed to the downside for the developed markets (DM), where consumer prices are more
sensitive to moves in oil prices.

The JPM economists say this modeled outcome undercuts their own house forecast and if the model is correct, this could accelerate monetary easing by central banks and boost consumer spending.

In response to this sharp boost to purchasing power, global consumer spending should accelerate in 2H12. Indeed, based on its historical relationship with oil prices, global consumer
goods spending looks set to accelerate to one of the strongest gains in over a decade.

Jim O’Neill, chairman of Goldman Sachs Asset Management, is also keen to flag the potential boost from oil prices and in a  series of slides  on the world economy he points out that the more important 5-year forward price of oil — which is less prone to spot market volatility — has fallen below its 200-day moving average.

As I have argued all year, I would rather trust the 5-year price than the spot price, and it is now below its own moving average. This has to be good news for anyone, other than those long crude oil.

So, oil to the rescue? Well, maybe. The 5-year forward price is certainly encouraging. However, the counterbalancing economic effects of spot price moves go both ways. As world markets rallied after the European Union’s summit last Friday made some progress on a euro zone crisis resolution, correlated spot oil prices perked back up too. Add in fresh nerves about the Iranian nuclear standoff on Tuesday and oil is suddenly back above $100 per barrel from lows below $90 last month. As it is, that brings the year-on-year drop in spot prices down to 10% from 20%+ at its height last month.

So, still a net positive on balance but a warning too of how ephemeral even this lonely positive can be.

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