Strategic Briefing | 3.25.2011 | Inflation & Oil Prices

Another year of living dangerously
The Economist | Mar 24
Even as higher oil prices and hobbled Japanese production reduce growth they add to mounting inflation risks (Britain is now fretting over inflation of 4.4%). But most rich-world economies have ample economic slack, and in several countries fiscal tightening will tug at recovery. Britain’s coalition government has reaffirmed its commitment to austerity with this week’s budget (see article), and America has begun to cut spending. Both the Bank of England and the Federal Reserve should resist the temptation to tighten soon. The European Central Bank seems intent on raising interest rates next month. That would be a mistake. In the euro zone underlying inflation and wage growth are both subdued and inflation expectations are under control. By raising rates the ECB would strengthen the euro and frustrate the efforts of countries like Greece, Ireland and—the next in line for bailing out—Portugal to grow their way out of their debts. There is only so much economic policymakers can do about crises that spring from war or nature. In this case, the priority should be not making matters worse.

Fed Wins Deflation Battle But Faces Tough Task On Inflation Investors
Dow Jones Newswires | Mar 24
“The Fed cannot have both low inflation and strong growth going forward,” said Mihir Worah, head of inflation-linked bonds at Pacific Investment Management Co., one of the world’s biggest asset management firms with over $1 trillion global assets under management. “The latest developments in Japan, Middle East and North Africa are on the margin stagflationary which means lower growth and higher inflation. This makes [the] Fed’s job harder.”
Will Central Banks Accommodate the Oil Price Shock?
Ed Dolan’s Econ Blog | Mar 24
The Fed seems least likely of any of the big three central banks to tighten its policy in response to rising oil prices. As in the case of the ECB, both legal and attitudinal factors come into play. Unlike the ECB, the Fed, by law, is tasked with balancing price stability against the need to fight unemployment, which remains very high. Also, the Fed, more than other central banks, focuses on core inflation, and on measures of expected inflation, neither of which is rising as rapidly than the headline CPI. Unless some strong indications of higher inflation emerge, for example, a sharp increase in long-term interest rates, it seems almost certain that the Fed will keep interest rates low and carry its current program of quantitative easing through to its scheduled completion in June. At that point, if oil prices are still on an upward trajectory, if Congress has still done nothing about the deficit, and if there are signs that headline price increases are spilling through into core inflation and indicators of expectations, a turn to a less accommodative policy becomes likely.
OBR warns on effect of inflation and rising oil price
The Telegraph | Mar 25
Inflation and oil prices remain the biggest risks to Britain’s economic recovery, the Office for Budget Responsibility has warned.
European Loan Growth Accelerated in February on Stronger Economy
Bloomberg | Mar 25
Increased lending may bolster the ECB’s case for an interest-rate increase next month. Officials, including President Jean-Claude Trichet and executive board member Juergen Stark, have signaled economic uncertainty caused by Japan’s earthquake may not deter them from lifting borrowing costs. The ECB wants to stem faster inflation fueled by stronger euro-area economic growth and oil prices surging above $100 a barrel. “Obviously loan growth mirrors the state of the economy so the overall trend is up,” said Nick Matthews, an economist at Royal Bank of Scotland Group Plc in London. “While loan and money growth are not yet inflationary, the ECB is still on emergency setting for policy rates and it wants to get away from that.”
Allianz Global Picks Gold, Oil to Lead Commodity Gains on Inflation, Rates
Bloomberg | Mar 25
Gold and oil will lead gains in commodities this year as investors seek to guard against rising inflation stemming from a global economic recovery and low interest rates, according to Allianz Global Investors.
China PBOC’s Yi urges caution on interest rate rises
Reuters | Mar 23
China is facing strong inflationary pressure, but will tread cautiously in raising interest rates, said Yi Gang, a deputy governor with the People’s Bank of China. Yi told a business conference in Hong Kong on Wednesday that he was confident the government would be able to keep annual average consumer price inflation to 4 percent this year. “We will see high (inflation) numbers in the first half of the year because of the base effect. Inflation in the second half will be lower,” Yi said. “So for the whole year, we will be able to meet the 4 percent goal.” Chinese inflation topped expectations at 4.9 percent in the year to February, near its fastest level in more than two years, and looks set to accelerate further in coming months as the economy races ahead and prices of food and commodities such as oil remain high.
Living With Rising Oil
International Business Times | Mar 24
The rise in the oil price will also boost inflation with roughly a $US10 a barrel rise adding 0.5% to inflation in the US and Australia and 0.7% to inflation in Asia. What would central banks focus on – inflation or growth? The European Central Bank is more likely to focus on headline inflation and so raise interest rates as it is threatening to do. However, the US Federal Reserve is likely to see a fuel inspired boost to inflation as temporary and would probably give more weight to weaker growth. At this stage it’s too early to get overly worried given that it’s quite possible that significant tensions in the Middle East and North Africa will be confined to current countries. Just as the much feared nuclear meltdown didn’t happen a week ago, a worst case oil price surge may be avoided.
The effects of the recent oil price shock on the U.S. and global economy
Nouriel Roubini and Brad Setser | 2004
Oil prices shocks have a stagflationary effect on the macroeconomy of an oil importing country: they slow down the rate of growth (and may even reduce the level of output – i.e. cause a recession) and they lead to an increase in the price level and potentially an increase in the inflation rate. An oil price hike acts like a tax on consumption and, for a net oil importer like the United States, the benefits of the tax go to major oil producers rather than the U.S. government.
Oil Price Volatility and U.S. Macroeconomic Activity
St. Louis Fed | 2005
Oil shocks exert influence on macroeconomic activity through various channels, many of which
imply a symmetric effect. However, the effect can also be asymmetric. In particular, sharp oil price changes—either increases or decreases—may reduce aggregate output temporarily because they delay business investment by raising uncertainty or induce costly sectoral resource reallocation.
High Crude Oil Prices Biggest Inflation Threat | Mar 24
Climbing international crude oil prices are the biggest threat to inflation in Chile as the country imports 98.7% of the crude it consumes, Finance Minister Felipe Larrain said Thursday.