Markets: There’s never a good time for an oil-price shock, but now is a particularly unfortunate moment. Higher oil prices risk harming global growth while adding to inflation. For policymakers and investors the challenges are great.
An oil shock’s first casualty is prices. Higher oil will be quick to drive inflation up further. It’s not just the direct impact on fuel. Pricier oil pushes up chemical and plastic prices and, by adding to distribution costs, can exacerbate food price inflation.
Policymakers need to recalculate. In fast-growing emerging economies, inflation is already a big concern. The monetary tightening evident in China, India, Brazil and other emerging economies may need to go further. But central bankers in export-led developing economies will probably be wary of the hit to global growth, and may be reluctant to push rates up. The clear danger is that global inflation gets worse.
It’s a different story in the developed world. The inflationary impact of soaring oil and commodity prices at least had the benefit of offsetting deflationary pressure in 2008. But today, central bankers will be wary of a too benign response. In Europe rate increases are now more likely sooner. The Bank of England's Monetary Policy Committee has become more hawkish, minutes released on February 23 show.
Political upheaval and soaring oil are a hit to confidence and to risk assets. Consider the heavy falls in global equities on February 22.
Not all commodities will be driven higher by oil; high speculative flows have also been a factor in the rampant prices of grains and some other commodities. Hence grain has tumbled in US markets this week. Meanwhile, gold, another traditional safe haven, has seen its price rise back to $1,400 per ounce. But it remains shy of recent peaks — a sign perhaps it is already overextended. Likewise silver has rallied around 10 percent in two weeks, although Barclays Capital describes its fundamentals as “weak”. The least bad assets would seem to be Treasuries, bunds and gilts. These seem likely to regain recently lost ground, as bonds’ safe-haven status trumps inflation fears. While unrest in North Africa persists, an uneasy paralysis is likely to grip investors and policymakers. A period of high uncertainty and of risk aversion seems to have begun.
