Just as global monetary policy switches toward high-altitude cruise control, another bout of turbulence is bearing down on the world economy with surging oil prices.
The approach of crude toward $100 a barrel is presenting central bankers with a reminder that the era of volatility heralded by the pandemic and war in Ukraine isn’t going away.
It showcases how the “higher-for-longer” stance that Federal Reserve Chair Jerome Powell signaled for interest rates at Jackson Hole last month is being framed more than ever by the “age of shifts and breaks” that his euro-zone colleague, Christine Lagarde, described at the same event.
Whether the crude spike is just a temporary blip or more enduring is a question confronting central bankers meeting this week from London to Washington—not least as oil can act both as a spur to consumer prices and a brake on economic growth. That trade-off will test the emerging consensus among officials that inflation risks are contained enough for them to pause tightening for now.
“The latest spike in oil prices is massively unhelpful,” Dario Perkins, an economist at GlobalData TS Lombard, said in a report. “That said, it is important to keep these recent inflationary developments in context. We are not yet in danger of undoing 12 months of solid disinflationary progress—not even close.”
Brent crude has reached a 10-month high around $95 a barrel as export curbs by Saudi Arabia and Russia combined with an improving outlook for the US and China to drive prices higher.
For central bankers, such commodity spikes can be an immediate red flag. International Monetary Fund staff, in a new paper looking at over 100 inflation shocks since the 1970s, found that only in about 60 percent of cases did consumer-price growth durably slow within five years.
If that increase ultimately means oil averaging $100 per barrel through the fourth quarter, that could inflict a peak impact of up to 0.9 percentage point on US inflation, according to Bloomberg Economics calculations. In the euro area and UK, it’s closer to 0.4 percentage point.
“Oil’s run is going to play a factor for all central banks” as inflationary effects start to move in the “wrong” direction, said Brad Bechtel, global head of foreign exchange at Jefferies LLC in New York.
Faster inflation would be a big blow for the bond market, which is already betting the Fed will have to hold rates elevated for longer to get price growth back to target.
Two-year Treasury yields are up more than 30 basis points since the start of the month, and are trading near a 16-year high seen in July. Yields across the German curve have edged up about 25 basis points this month alone, leaving the 10-year tenor close to the highest level since 2011.
Such concerns hang over a pivotal week for global monetary policy, with the Fed preparing to pause tightening on Wednesday, albeit with a possible hint at more action.
On Thursday, the Bank of England, Norges Bank, Sweden’s Riksbank and the Swiss National Bank may follow suit with what could turn out to be either a final or penultimate increase in borrowing costs, and a pledge to hold them high.
The Bank of Japan on Friday isn’t expected to take any major steps, but the communications groundwork appears to be under way for the eventual scrapping of the last negative policy rate among major economies.
Last week, the European Central Bank signaled a pause after a close-run decision to raise rates again—a move that its former chief economist, Peter Praet, immediately linked to rising crude.
“Consumers, households are extremely sensitive to oil prices and food prices, so I think it was right for the ECB to send a signal,” he told Bloomberg Television after the announcement.
Inflation expectations in Europe are pushing higher. The market is betting consumer prices will rise around 2.4 percent on average over the next three years, well above the ECB’s target, and up from less than 2 percent just two months ago.
Australia’s central bank sees “upside risks” to global inflation in the months ahead from food and oil prices, minutes of its Sept. 5 board meeting showed Tuesday. Higher fuel prices are expected to boost domestic headline inflation in the current quarter.
The Reserve Bank of Australia still expects broader prices to moderate, though inflation is unlikely to return to within its 2-3 percent target band before late-2025. Economists worry the RBA will have to upgrade its economic forecasts, which are currently based on a Brent crude price of $80 per barrel, much lower than around $95 now.
The risks go both ways. Highlighting that dual danger, the Bank of Spain on Tuesday warned that inflation will be faster than it had anticipated this year and next because of costlier crude, while economic expansion will be weaker too.
Those worries dragged the euro to a six-month low last week, with markets betting the European economy can’t withstand higher rates. Traders are already pricing more than two quarter-point cuts next year and looking past guidance from the ECB that borrowing costs will remain elevated for longer.
Last year, the continent was thrust into a crisis after it was cut off from Russian gas and saw the euro plunge through parity with the dollar. The jury is still out on how well it can cope this year if prices drift ever higher.
Growth prospects also worry OECD Chief Economist Clare Lombardelli. She told reporters on Tuesday that the impact will be “a squeezing on household budgets and on demand”—and that Europe will suffer more than the US because of its dependence on energy imports.
Taxes in Europe mean that there’s less sensitivity to cost changes there than in the US. Last year, the pump cost of gasoline in Germany and the UK was roughly double that of the US.
Fed officials may fret more about the impact on growth than inflation. According to Anna Wong, chief US economist at Bloomberg Economics, the central bank’s own model suggests policymakers are slightly more likely to react to higher commodity prices with a rate cut than a hike.
“It really impacts, if you will, the growth side of the Goldilocks equation rather than the inflation side of things over the long term,” Maya A Bhandari, head of multi asset at BNP Paribas Asset Management UK, told Bloomberg Television.
In the US, the rise in oil prices comes at a time when consumer balance sheets are already showing signs of strain. Interest payments are eating up a higher share of disposable incomes and excess savings built during the pandemic are close to exhaustion.
Higher energy costs will probably help restrain consumer spending, giving the central bank less reason to continue tightening. Fed officials will be on high alert for any signs that inflation expectations are drifting higher, but so far, that hasn’t happened.
For now, Bloomberg Economics doesn’t yet reckon policymakers will be forced to react one way or the other.
“Standard models imply policymakers would probably look through this sort of shock,” Ana Andrade and Jamie Rush wrote in a report. “Our base case is that the shock is not yet big enough to change the outlook for interest rates.”
To guide their response, central banks have the bitter memory of the 1970s—a time when protracted oil shocks driven by supply constraints left advanced economies with both enduring inflation and a fallout on growth.
Given that backdrop, just as some policymakers have argued that the key question for rates now isn’t how high they rise but how long they stay there, the same test applies to how any prospective crude spike plays out.
“Central banks can’t do anything about these short-term supply-driven shocks, but they can do something to keep expectations in line,” Charles Seville, an economist at Fitch Ratings in London, said in an interview. “This is the big difference with the 1970s—we now have central banks that have more of a track record in bringing inflation to target.” With assistance from Zoe Schneeweiss, Rich Miller, Matthew Boesler, Swati Pandey, James Hirai, Jana Randow, Reed Landberg, Alix Steel, Guy Johnson, William Horobin and Kriti Gupta/Bloomberg
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