Falling oil prices signal good news for global economic growth

Perhaps the most significant development on world markets in recent times has been the collapse in oil prices since the summer, over 50% since June 2014.

It looks like the price fall will prove sustained as there is no sign of a cut in production to try and boost oil prices, even though global demand is weak.

Notably, Opec has decided to maintain current high production levels in spite of the glut in oil supply.

The impact of the slump in oil prices is already being felt in terms of a marked fall in inflation. Indeed, the CPI rate turned negative in the eurozone in December as a result of falling energy costs. We also expect to see negative inflation rates in Ireland soon.

Core inflation, which excludes energy, should also fall in time, as lower production and transport costs lead to price cuts.

All of this means that a key effect of falling oil prices is a rise in the real incomes of households and thus consumer spending power. The IMF published a paper before Christmas in which it attempted to estimate the impact on global growth of the slump in oil prices. Overall, it views it as a badly needed shot in the arm for the world economy.

The IMF models suggest that the fall in oil prices could boost world GDP by up to 0.7% in 2015 and 0.8% in 2016, assuming that oil production does not fall back sharply, causing prices to rise again. Indeed, prices have continued to decline since the IMF paper was published.

The results mask major differences across countries. The big winners are large oil importers like China and Japan and big energy consumers like the US. The losers are the major oil exporting nations like Russia, Nigeria, Venezuela, Norway and the big oil producers in the Middle East.

The fall in oil prices is also having other effects that could boost growth. The associated sharp fall in inflation is encouraging central banks such as the US Federal Reserve and Bank of England to hold off on raising interest rates. Meanwhile, the Bank of Japan and ECB are loosening policy even further to counteract deflation risks, with the ECB expected to soon launch a major quantitative easing bond-buying programme.

The easier monetary stance is having a major impact on fixed income markets. Long-term bond yields have fallen sharply in recent months. This represents a significant loosening of monetary conditions, with funding costs falling for the public and private sectors.

German 10-year government bond yields have fallen to historic lows of just 0.5%. Yields on German bonds out as far as five- year maturities are yielding close to 0%.

Meanwhile, the Government raised €4bn in a new seven-year bond issue last week at a yield of just 0.87%, with 85% of the buyers made up of overseas investors.

However, if the oil price slump is sustained and starts to have a significant impact on world growth, as suggested by the IMF, then central banks in strongly growing economies like the US and UK, will have to take note.

They will need to look through the temporary fall in inflation and start to tighten monetary policy later this year.

This is likely to put upward pressure on bond yields. Overall, the collapse in oil prices is a welcome boost for the under-performing world economy. Combined with very low interest rates virtually everywhere, and a moderation of fiscal tightening, it should see global growth at last shift upwards during 2015.

However, there have been a few false dawns for the recovery in the global economy since the end of the so- called Great Recession of 2008-09. Let’s hope this is not another one.


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