World economy inflation shock set to worsen from oil at $100

Summary:

• Rising crude oil prices can stoke inflation and hurt growth
• The energy surge comes as central banks raise interest rates

Oil's surge to $100 a barrel for the first time since 2014 represents a double-blow to the world economy by further denting growth prospects and driving up inflation.

That's a worrying combination for the US Federal Reserve and fellow central banks as they seek to contain the strongest price pressures in decades without derailing recoveries from the pandemic. 

Futures in London jumped as much as 3.3% as Russia's dramatic escalation of the Ukraine crisis sparked fears of a disruption to the region's critical energy exports.

While energy exporters stand to benefit from the boom and oil's influence on economies isn't what it once was, much of the world will take a hit as companies and consumers find their bills rising and spending power squeezed by costlier food, transportation and heating.

In an analysis of the winners and losers from oil's surge, Bloomberg Economics estimates Saudi Arabia can look forward to a windfall, Russia gains, while smaller oil exporters like the United Arab Emirates fare better too. The biggest losers would be energy importers such as Korea, India and Japan.

"The oil price run-up will intensify the pressure on central banks worldwide to bring forward their tightening cycle and hike rates more aggressively to contain inflation risks," said Chua Hak Bin, senior economist at Maybank in Singapore. 

Price Shock

Group of 20 is confronting surging inflation stoked by energy costs

More broadly, JPMorgan Chase & Co. warns a run-up to $150 a barrel would almost stall the global expansion and send inflation spiraling to over 7%, more than three times the rate targeted by most monetary policy makers.

Oil has surged along with a broader rally in commodity prices that's also swept up natural gas. Among the drivers: A post-lockdown resurgence in worldwide demand coupled with the geopolitical tensions and strained supply chains. Prospects for a renewed Iranian nuclear deal have at times cooled the market.

Fossil fuels -- oil, as well as coal and natural gas -- provide more than 80% of the global economy's energy. And the cost of a typical basket of them is now up more than 50% from a year ago, according to Gavekal Research Ltd., a consultancy.

The energy crunch also compounds the ongoing squeeze in global supply chains, which drove up costs and delayed deliveries of raw materials and finished goods.

Global Rebound

The IMF predicts that global growth will moderate in 2022 and 2023.

The International Monetary Fund recently raised its forecast for global consumer prices to an average 3.9% in advanced economies this year, up from 2.3%, and 5.9% in emerging and developing nations.

China, the world's biggest oil importer and goods exporter, has so far enjoyed benign inflation. But its economy remains vulnerable as producers are already juggling high input costs and concerns over energy shortages.

With price pressures proving more tenacious than earlier expected, central bankers are now prioritizing inflation-fighting over demand support. US consumer prices surprising to a four-decade high sent shocks through the system, increasing bets that at one point had suggested the Fed will raise rates as many as seven times this year, a faster pace than earlier expected. 

Bank of England Governor Andrew Bailey has partly justified the decision to raise U.K. interest rates by pointing to a "squeeze from energy prices." European Central Bank President Christine Lagarde said recently that officials will "carefully examine" how energy prices will impact the economy as they signal a shift toward tightening. The Reserve Bank of India has also flagged oil prices as a risk. 

Speaking to reporters Thursday after the Bank of Korea's policy meeting, Governor Lee Ju-yeol flagged the risk of the Ukraine crisis impacting global commodities markets and fueling inflation.

To be sure, the world economy is no longer the oil guzzler it was during previous decades, especially the 1970s, and alternative energy offers some buffer. Other pandemic-era insulators include swelling household savings and higher wages amid a tight labor market.

In the US, the emergence of the shale oil industry means its economy is less vulnerable to fuel shocks: While consumers are paying more for gasoline, domestic producers are earning more. 

Paul Donovan, UBS Group AG chief economist at global wealth management, said it's important to consider how oil-producing economies spend their extra revenue, which could ultimately help global growth. "Nowadays, oil sellers are very inclined to spend the revenues they get when prices go up," Donovan said in a video presentation to clients.

For most consumers, and central bankers, much rides on how fast and how far energy goes, particularly if economies lose momentum globally.

A big enough oil shock could derail the normalization plans of many central banks, according to JPMorgan economists "although the high inflation backdrop and concerns about anchored inflation expectations means policy would still be tighter than if inflation were currently running low." 

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.