Oil prices continues to increase inflation
Headline inflation has been pushed higher, in no small part due to rising oil prices. During the run-up in oil prices in the first three quarters of last year, central bankers were relatively relaxed about their second-round inflationary effects. Concerns, particularly in the eurozone, centred more on the depressing impact these higher oil prices could have on the economy. Central bankers are fretting about the possibility that the increase in headline inflation will pass through to the core rate and that building inflationary pressures need to be suppressed.
Crude oil prices have only dropped back slightly from their peak of close to $75/barrel in early May. However, at close to $70/barrel, they are still up over 15% from their start-year levels. So, are the central bankers right to be concerned? Has oil moved to a new level or is the latest increase a temporary phenomenon?
The upward trend in oil prices over the past couple of years reflects strong underlying demand pressures as the world economy expands. Strong growth in the emerging economies of China and India and a revival of growth in the US have combined to push up overall demand levels.
On the supply side, OPEC decided to leave output unchanged at current high levels at last week’s meeting.
OPEC is concerned that current high prices could depress demand by slowing global economic growth. The downward pressure of OPEC’s decision on prices, though, has been limited with, among other factors, expectations of another active summer hurricane season in the US underpinning prices.
Oil prices are also being supported by the disruption to supplies from Nigeria (where militant unrest has taken out around a quarter of the output) and fears that output from Iran could be disrupted over its nuclear ambitions.
It is hard to see the overall environment, which has seen oil prices move up from around $20/barrel at the start of 2002, changing radically in the near to medium term.
While there is scope for prices to ease somewhat from recent high levels, prices remain underpinned by long-term demand from the US and the fast-growing economies of China and India. Indeed, as long as the world economy continues to grow strongly, price pressures will continue given the shortage of refineries.
Meanwhile, fears over supply from Iran, Iraq and Nigeria are unlikely to ease in the near term.
Any severe disruption to supplies has the potential to push prices substantially higher.
Indeed, the risks of further price spikes due to hurricane and other supply side risks will only add to fears about second-round consumer price effects, with potential for further consequential knock-on impact on central bank thinking.
John Beggs, Chief economist AIB Global Treasury
