Here's how rising oil prices could affect global economic growth

Oil prices are flying high. (EyesWideOpen / Getty Images)
  • Capital Economics says higher oil prices have previously weighed on global economic growth.
  • But this time, oil-producing nations are more likely to invest any additional windfalls.
  • Furthermore, central banks are likely to hold the line on raising interest rates if oil prices push inflation higher.

Oil’s rally continued last week as benchmark crude closed above $US77 a barrel for a weekly gain of 3%.

Prices have now risen by 70% since June last year, as OPEC’s production cuts take effect while heightened tensions in the Middle East have further dampened the supply outlook.

And it’s led an increasing number of analysts to begin questioning how it will affect the outlook for the global economy.

For one thing, higher oil prices means a higher rate of headline inflation.

Capital Economics analyst Andrew Kenningham said that if oil prices hit $US100 a barrel by 2020, it would add around 0.5% to global rates of inflation.

An unexpected rise in inflation could put further pressure on interest rates, just as the US Federal Reserve leads a steady but coordinated tightening of global monetary policy.

But Kerringham isn’t too concerned. He expects policy makers will hold the line in the face of rising headline inflation pressures stemming from higher oil costs.

“Policymakers would probably ‘look through’ this increase rather than tightening policy, because any rise would be short-lived and should have little impact on underlying prices pressures,” Kerringham said.

Instead, Kerringham raised the prospect of reduced economic activity as capital shifts towards governments of oil-producing nations.

And when income flows from consumption-based economies such as Europe and the US to oil producer nations like Saudi Arabia and Norway, it can act as a drag on growth.

“These producers have typically saved more of their income than the consumers, so the net effect has been to reduce global demand,” Kerringham said.

However, the austerity-based measures of the world’s big producers may now be a thing of the past.

“Many oil producers, including the Gulf economies, have been implementing austerity since oil prices slumped in 2014-15,” Kerringham said.

“They would probably loosen their purse strings if oil prices rose, rather than simply squirreling away the extra income.”

So on a global scale, Kerringham expects economic growth to remain fairly resilient.

That won’t necessarily provide much comfort to Australian consumers at the domestic level, with higher energy costs adding to consumption headwinds from low wage growth and high household debt.

But for his part, Kerringham predicts that a decline in oil prices is more likely than further gains in the near-term.

“We think oil prices will probably drop back over in the coming months: our forecasts for Brent are $65 per barrel and $75 per barrel for the end of this year and next respectively,” Kerringham said.

He said the impact from another round of US sanctions on Iran will be less severe, because Europe won’t be getting involved this time.

And the Kerringham is a believer in the US shale oil story, while higher oil prices likely to attract shale producers back into the market.

He added that shale producers can be more nimble in their supply response than conventional drilling operations or deep-sea oil rigs.

“All in all, the world economy should remain fairly resilient even if oil prices were to continue on a steady upward trend,” Kerringham said.

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