Oil prices remain key for world monetary policies

What happens to the price of oil in the coming months will be critical to the global inflation outlook, and, of course, to the monetary policy of the world’s major central banks.

Despite agreed production cuts from the OPEC and other producers, oil prices remain lower than at the start of the year, with markets still concerned over a supply glut.

Saudi Arabia, in particular, has an incentive to push prices higher. Riyadh can’t afford an oil price of $50 a barrel or below. According to market estimates, oil needs to be trading at $55, at least, for Saudi Arabia to hit its budget-deficit target of $53bn in 2017.

Recently, Mohammed bin Salman was named as the country’s new crown prince. Now deputy prime minister, the 31-year-old retains

defence, oil, and other portfolios. He is pushing through economic reforms and has overseen conflict in Yemen and a bitter dispute with Qatar.

Bin Salman now has greater powers to push through reforms of the Middle East’s largest economy and even a stronger hand in settling old scores with Gulf neighbours.

But it is in tackling the low oil price that he can make a big difference relatively quickly.

Production in the US is

recovering faster than expected and global stockpiles remain brimful.

The International Energy Agency says inventories in industrial nations are 292m barrels above their five-year average, which is the equivalent of 29 days of Saudi’s current output.

The question is whether he decides to pursue a very hard line towards Qatar and Iran, or work towards an oil-price recovery.

Now that his grip on power is more assured, he can afford to do the latter. But, as things currently stand, it looks like oil prices will continue to struggle to make serious gains over the next few months.

Lower oil prices will weigh on headline inflation, which is good news for consumers and comforting for some central banks (Bank of England and ECB), but a likely communication headache for others (US Federal Reserve).

For the BoE, worried about the impact of higher headline/core inflation, low oil prices will deliver some comfort. It has already used hawkish communication, at recent policy meetings, to

cement the view that it has not gone soft in fighting

inflation.

This strategic use of

communication should be seen as another form of

expectation management, although less explicit, helping to limit the damage to sterling.

The weak pound is already impacting on Irish food

exports to the UK and on

Ireland’s tourism industry.

For the ECB, which has made a distinction between its less pessimistic view on economic growth and its largely unchanged view on inflation, a lower oil price will keep a lid on policy-tightening expectations.

The ECB wants to remove current emergency policy, which is geared toward

deflation risks, and which likely requires less negative interest rates. However, in terms of impacting directly on mortgages, we are still some way off higher interest rates, with no change before 2019, at the earliest.

The bigger headache will be for the US central bank, where the focus remains on the prospect of further

labour market strength, which is already at/near full employment.

The Fed will continue to highlight the labour market in support of its optimism over the inflation/wage outlook, and thus stick with its policy normalisation plans, which will likely include

another interest-rate hike before the year is out.

Higher rates should be positive for the dollar, though the euro is still expected to end the year at $1.15 to $1.20.

While the BoE policy outlook is a function of Brexit negotiations, the Fed and ECB have less time to gauge how oil prices will evolve, given key policy meetings in September/October.

Further weakness in oil prices would push headline inflation down further and probably see greater caution from them.

Still, it is unlikely to derail them from the gradual move away from the ultra-loose/emergency policy measures, which have been in place since the global financial

crisis.