Yesterday there were some extraordinary developments in the oil market as first rumours circulated and then OPEC (Organisation of the Oil Producing Countries) produced this statement.
Accordingly, in the interest of restoring market equilibrium, the Conference decided to maintain the production level of 30.0 mb/d, as was agreed in December 2011……..The Conference resolved that its next Ordinary Meeting will convene in Vienna, Austria, on Friday, 5th June 2015,
So, not only did it decide not to respond to falls in the oil price which had reached some 30% on a year before but the timing of the next meeting meant that no change was in the offing either.
Rout,slump or crash?
I will leave readers to pick their own paragraph heading for what happened next. The reality was that the price of a barrel of Brent Crude Oil fell 6% on the day to below US $73. The usual pattern after such heavy falls is for a market to dip again the next morning and we have seen that at the time of typing this as the price has fallen further to below US $72 so far today. This leaves the oil price some 35% below the level of a year ago and the consequences of that are my subject of today.
Back on the 20th of this month I mentioned some research on this subject from the Cleveland Federal Reserve which told us this and the emphasis is mine.
there is some concern that low oil prices, which have continued to remain below $90 a barrel through October, will keep inflation persistently below or even push it further from targeted levels.
I would like readers to keep in their minds the idea of something (lower inflation ) which is good for them being of “concern” for central bankers, but the latest falls will have some important consequences. l summarised the UK situation with this tweet yesterday.
Dear Chancellor what is the form for writing to you about UK CPI falling below 1%? Yours Respectfully Mark Carney Governor
Just over a fortnight ago Bank of England Governor Mark Carney indicated that the subject was on his mind. From the BBC.
In a news conference at the Bank of England, Mr Carney said it was likely he would soon have to write a letter to the Chancellor, George Osborne, explaining why inflation had dropped below 1%.
I do hope that he has a proper fountain pen with which to sign what will be one of a kind at least initially. You see all the explanatory letters from the Bank of England Governor have been so far for above target inflation.
If we skip across the Channel to Europe there are consequences for the Euro area and the European Central Bank too. It seems rather likely now that we will see a 0% print for Euro area consumer inflation (CPI) and we could easily see a negative one. This poses a real problem for the ECB which has set people’s expectations around the consumer inflation rate in what has turned out to be something of an own-goal. I still recall former ECB President Jean-Claude Trichet boasting about the CPI in the Euro area averaging 1.97%.
What is the impact on us?
The Office for Budget Responsibility (OBR) looked at this matter back in 2010 and concluded this.
A £10 a barrel rise in the oil price would raise the pump price of petrol and diesel by 7.4 pence a litre if fully passed through.
If we now look at the last year then the oil price has fallen by £22 a barrel so we would expect there to be a total fall in diesel and petrol prices at the pump of 16 pence. According to the official figures we have seen a 7.7p fall in the petrol price and a 10.6p one for diesel. Thus we should see a 8 pence fall in the petrol price and a 5/6p fall in the diesel price ceteris paribus.
We can take this further as the OBR gave us some benchmarks.
Road fuels have a weight of around 4 per cent in the CPI and 5 per cent in the RPI basket.
If we apply its benchmarks then according to its analysis the fall in the oil price would if you measured inflation today make it some 0.55% lower in terms of the UK official CPI and by 0.66% in terms of the Retail Price Index than a year ago. Of course some of this effect we have already seen but there is an additional factor raised by the OBR.
There could be an additional impact on inflation if higher oil prices lead to a rise in electricity and gas bills. Electricity and gas bills have a weight of 3.5 per cent in the RPI and 4.4 per cent in the CPI, so a similar rise in prices to that of road fuel could roughly double the impact on inflation.
They were discussing a rise here but if we assume some symmetry we see that we could now be discussing a 1.1% lower annual rate of CPI than otherwise and a 1.3% lower rate of RPI. That is before we discuss the second-order effects of such a move.
I counsel caution about the precise accuracy of such forecasts but we have a clear trend which hints that Mark Carney might like to make sure that his fountain pen has a ready ink supply! He may have some luck in January as prices fell by 0.6% this year on a monthly basis but apart from that should we remain in similar circumstances then as Glenn Frey put it.
It’s on the street
The heat is on, the heat is on, the heat is on
Yeah it’s on the street
The heat is on
What about Europe?
Earlier this year the European Parliament took a 232 page look at energy prices and in the context of today’s analysis my eyes alight on this bit.
On average, the non -regulated price components, most importantly the wholesale energy costs have a share of 40% -60% of the retail prices in the 10 selected Member States. Consequently,any impact of the oil price on wholesale prices only affects 40- 60% of the final consumer price (except for value added tax – VAT).
So the first round of price cuts should be for falls in pump and heating prices of around 50% of the fall in the Euro value of the oil price. As we stand that means a considerable boost to output and a bite-sized chunk out of consumer inflation. Less than an hour ago Eurostat told us this.
inflation is expected to be 0.3% in November 2014, down from 0.4% in October.
A 0% print would send the media into a deflation frenzy which would only be doubled if we got a negative consumer inflation print.
What about ECB Quantitative Easing?
I think that either of the two occurrences in the last sentence of the above paragraph would make it pretty much nailed on as a certainty. After all the ECB is an inflation targeting central bank and as i discussed yesterday it is currently claiming expansion whilst actually being in a holding pattern at best. If we factor in that the unemployment rate in Italy has hit a record (since 1977) of 13.2% this morning the pressure mounts.
Such expectations are now built into Euro area government bond yields where the German ten-year benchmark is at 0.7% and even more extraordinarily France is at 0.98%.
I have analysed one specific area today and we see that should things remain where they are measures of inflation have just been given a substantial downwards push. Ordinary people like you and I will welcome this as the prospect of cheaper goods and services comes into view. However central banks will not treat an undershoot of their inflation targets in the “same casual manner” to quote the television series Porridge as the Bank of England did with its overshoots. My suggestion that a Base Rate cut is as likely as a rise has been further reinforced by these events. The caveat comes from an economics paper written in 1976 by Rudiger Dornbusch about financial markets overshooting so let us wait and see what happens next.
How do I expect central banks to respond to this? Well I will leave that to the band Foreigner.
You say it’s urgent
Make it fast, make it urgent
Do it quick, do it urgent
Gotta rush, make it urgent
Want it quick
Urgent, urgent, emergency
Urgent, urgent, emergency
As to the falls in bond yields well as I look back through my career the words of Turkish in the film Snatch come to mind.
Who da thunk it?