Central bankers who spent past weeks puzzling over how financial turmoil will impact their outlook now have a jolt in the form of higher oil prices to consider.
The surprise production cut announced by OPEC+ on Sunday and the danger of another surge in crude costs complicates the debate in Frankfurt, London and Washington about where inflation is headed and how much further interest rates should rise to control it.
“We began to see some signs of inflation normalizing, and here we go again — another problem,” Marija Veitmane, a strategist at State Street, told Bloomberg Television. “We have strong labor markets, we have consumers who can spend, and now oil prices are coming up. So it’s increasingly challenging for central banks.”
OPEC’s decision marks the third Monday in less than a month when global monetary officials have woken up to a new headache, with episodes of market turmoil following the collapse of Silicon Valley Bank and the forced takeover of Credit Suisse Group AG each having threatened to derail interest-rate hiking plans.
This time, rather than emboldening dovish arguments for caution at institutions from the Federal Reserve to the Bank of England and European Central Bank, it will pot
What Bloomberg Economics Says …
“The cuts will likely result in slower global growth, higher inflation and may pressure central banks to act more forcefully.”
—Ziad Daoud, chief emerging markets economist for Bloomberg Economics. Click for the GLOBAL INSIGHT.
Money markets aggressively pared rate hike wagers last month following the banking turmoil, at one point betting the Fed, ECB and BOE would no longer need to tighten policy any further. But traders loaded back up on rate hike bets last week after faster-than-forecast inflation figures out of Europe suggested policymakers would need to continue raising interest rates.
A 60% chance is now assigned to a quarter-point Fed hike in May compared to 55% on Friday before news of the oil output cut broke. Traders also added to BOE and ECB tightening bets, pricing 4.69% and 3.63% peak rates respectively.
The timing could not be more awkward. After the fastest monetary tightening cycle since the late 1980s, investors were starting to price in a pause in rate rises.
“The inflationary pressures are still there,” said Kiran Ganesh, global head of investment communications at UBS Wealth Management. “If we don’t see this big slowdown in economic growth as a result of the issues in the banking sector, then we’ve got a new constraint on the global economy which could mean that inflation remains higher for longer.”
That danger will depend on how enduring and abrupt the latest move will prove on crude, on wider energy costs, on headline consumer prices more generally and then on underlying measures that policymakers are watching with more intent at present.
Fluctuations in the oil price often have blindsided policy makers, who have divided on exactly how they feed through into the economy.
Given that backdrop, it’s no surprise that some economists see a case to wait and see before drawing conclusions. So far on Monday, the benchmark West Texas Intermediate crude contract rose as much as 8% to above $80 a barrel. Brent crude surged above $84.
While that’s a big jump, it only returns prices to where they were at the start of March, and they’re still down considerably from a year earlier. Some investors were talking about oil headed to $100 a barrel for Brent, a level that would be more shocking for the economy.
While higher oil prices would ordinarily result in higher gasoline prices at the pump and transportation costs, they also would tend to hold back the pace of economic growth, perhaps providing downward pressure on inflationary forces. But much larger forces are buffeting the broader picture for central banks — like the meltdown in the banking market that resulted in rescues for two major banks and the shortage of labor that’s driving up wages.
“The effects on inflation from this rise in oil prices are pretty small so far compared to the large ongoing effects from previous swings,” said Michael Saunders, a former UK policymaker who is now at Oxford Economics. “With the rapid rate rises since mid-2022, the ECB, Fed and BOE have now largely got on top of their inflation problems. At this stage, this rise in oil prices does not alter that view.”
At the ECB, Governing Council member Gediminas Simkus said officials need to look at a range of factors when setting interest rates — and OPEC is just one of them.
“Inflation is slowing and there are more factors there than the OPEC+ decisions,” Simkus, who also heads Lithuania’s central bank, said Monday in Vilnius. “In the context of interest rates, general trends are most important. In the last reading, we saw core inflation grew.”
But what if the move in the oil price were to extend significantly higher? Given the OPEC+ cut, Goldman Sachs analysts raised their forecast for Brent crude in 2024 to $100, an outcome that could automatically feed into a higher headline inflation rate.
That’s a possible scenario likely to cause significant divergence in views among policymakers, with worries about consumer-price stickiness likely to clash with concerns about a hit to growth.
“Central bankers are very fixated at this stage on bringing inflation down and focusing on what’s going to happen to inflation expectations,” said Freya Beamish, chief economist at TS Lombard in London. “When I think a supply shock like this, I think, well prices are going to rise, it’s going to destroy demand, and that’s going to feed into recession.”
