Low oil prices are usually great for the world economy.
After all, low oil means it’s cheaper for companies to export goods, less expensive for people to run their cars and should boost spending across the board.
However, analysts at Hermes Investment Management warned in a note titled “The confusing price of oil” that there is no evidence of this happening.
In fact there are some crazy things happening in the world’s markets right now that show that the global economy is being impacted negatively from low oil (emphasis ours):
Traditionally we have believed that oil price declines would provide a net positive boost for the world economy, the balance between a negative effect on the growth of exporters more than offset by a positive effect for importers of the commodity.
For lower oil prices to feed through to positive economic growth, one would typically expect a boost in spending, but we have not seen any evidence of that this time — rather, public investment has been falling, and many countries have no capacity for any additional borrowing that could provide the necessary stimulus.
Country officials and central bankers, like Bank of England Governor Mark Carney, have claimed low oil prices are a net benefit for the economy.
Carney’s point is that, for Brits and others in the developed world, it’s largely a good thing. As oil prices fall, so do petrol prices. That boosts car sales and also means consumers have more money in their pockets to spend on other goods and services, boosting growth.
Two things which are hindering low oil prices helping the economy
Oil prices are currently hovering around he $40 per barrel mark — over a 60% drop from the triple figures last seen in June 2014.
However Hermes points out there are some dislocations in market fundamentals that are preventing the benefits from filtering through:
1. “The size of the current decline has had a significant direct effect on capital expenditure in the oil and gas sectors too, with knock-on effects to other parts of the economy” — for example, it’s putting companies out of business and leading to huge numbers of layoffs at giants like Shell. It’s also depressing spending power in oil-dependent emerging markets like Brazil, where consumer-facing companies such as Unilever get a lot of their sales from.
2. “All major central banks have been pursuing unconventional monetary policy of one form or another — this has left them in a position of not being able to further lower rates to support growth alongside the reduction in oil price” — for example, six central banks, including the European Central Bank and the Bank of Japan, have implemented negative interest rates which carry a huge risk of disproportionately impacting banks rather than serving as a boost to the economy.
All in all, it’s looking pretty bleak for world economy if oil prices stay this low because the markets and economy are not reacting in a way that analysts had hoped and predicted for in the past.
“This current episode of lower oil prices has come at an unusual, and to some extent unprecedented, time for the global economy,” said Hermes analysts in the note.
“As such we have seen unexpected dislocations and feedback loops that require us to reconsider the effects of lower oil prices, at least in the short term.”