Tags: inflation

High Oil Prices Do Not Mean Inflation

By Hans Parisis
Friday, 29 May 2009 09:58 AM Current | Bio | Archive

The eurozone, 16-country area CPI inflation number just came in absolutely flat at a worrisome 0.0 percent year-over-year, which is the lowest year-over-year CPI rate on record and far below their official inflation target rate of 2 percent. Still, I don’t think I’m making an overstatement by saying they are literally vacillating at the brink of deflation while keeping high the ECB real interest rates.

At the same time, year-over-year U.S. inflation was revised down to 2.8 percent, which means real negative U.S. Fed interest rates; and we see a very unusual, but also somewhat contradicting, situation developing where oil prices continue climbing in advance of any real economic recovery taking hold. Rising oil prices are by themselves not a positive to economic growth outside the oil production areas. On the contrary, they create a real downside risk to the near-term global growth expectations.

The important and seemingly contradicting outcome of the OPEC meeting is that Saudi Arabia, which holds most of the spare production capacity, now endorses publically an oil price target of $75 to $80 per barrel, while it has dropped its previous stance that oil prices should be kept low to support an economic recovery.

For the United States, especially after a worse than expected 5.7 percent annualized drop in GDP that followed a 6.3 percent contraction the first quarter, this could indeed translate into a major concern for an economic recovery because of a possible resulting pickup in headline inflation that would squeeze household real incomes and, consequently, consumer spending.

Rising oil prices are always very quickly and fully passed through to U.S. gasoline prices, and if oil prices should continue moving toward the Saudi target of $75 to $80 per barrel, we could see sequential higher inflation in the third quarter of even above plus +3.5 percent quarter-over-quarter annualized.

The big questions remains, of course, if oil prices will continue to rise, and if so, whether U.S. households will smooth spending through this period, as currently is mostly assumed.

From one side, I don’t expect an oil disaster price in the making, but from the other side I ask myself more and more, what is still normal these days?

Notwithstanding, we should remember that crude oil volumes entering the market are still well in excess of actual and expected demand. In addition, crude stocks remain high, as well as reduced OPEC members' compliance with production targets in the months ahead. At the end April, the OECD commercial oil inventories were close to the record high we saw in February 1998.

Despite recent positive economic indicators pointing towards a possibility of the recession bottoming out before year-end, the world nevertheless still faces weak industrial production, shrinking world trade, high and still rising unemployment that will keep oil demand low in the foreseeable future.

That said, we also know that OPEC members need an oil price of about $50 per barrel to balance their budgets. Nevertheless, some like Saudi Arabia now aim the $75 to $85 range. Here I must question if the Saudis are setting up a political bargaining chip for the coming talks with President Obama.

Yes, today, high oil prices don’t equal a high dollar. It is a fact that the current $60 range is a comfortable price zone for most OPEC members.

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HansParisis
The eurozone, 16-country area CPI inflation number just came in absolutely flat at a worrisome 0.0 percent year-over-year, which is the lowest year-over-year CPI rate on record and far below their official inflation target rate of 2 percent. Still, I don’t think I’m making...
inflation
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2009-58-29
 

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