Energy price boom’s inflationary impact from oil is not that clear cut
London — Energy prices are booming, but the inflationary impact from high oil is not so clear-cut.
Once exchange rate differentials are taken into account, the resulting price pressures are less severe than they look at first glance. This is important for the European Central Bank (ECB), as it allows it to tighten policy far more gradually than might otherwise be the case.
Brent crude oil futures topped $70 a barrel last week for the first time in more than three years, meaning the price has more than doubled from the multi-year low of $27.10 in January 2016.
More importantly for central bankers calibrating policy based on the inflation outlook for the year ahead, oil is up more nearly 30% over the past 12 months.
An International Monetary Fund (IMF) working paper published in September last year found that a 10% rise in oil prices typically increases domestic inflation by 0.4 percentage points in the short term, or the year of the price spike, with the effect vanishing after two years. This applied to both advanced and developing economies.
"Since many episodes of oil price shocks involve increases of 50% or more, this is an economically significant effect," the paper’s authors wrote.
In the past two years, oil has leapt a highly significant 150%, but this significance varies when exchange rates are factored in.
The dollar-denominated price of Brent is up just shy of 30% in the past year. All else being equal, that would indicate a US inflationary impulse of about 1.2 percentage points over the next year, according to the IMF paper.
The inflationary impulse in the eurozone would be far less severe because oil is up just less than 10% over the past 12 months in euro terms. All else being equal, this should lift eurozone inflation about 0.4 percentage points in the coming year.
With eurozone inflation currently running at 1.4%, this would raise inflation towards the ECB’s target of "below, but close to, 2%". A counter force to oil’s strength is the strength of the euro. It’s up 15% against the dollar over the past year, this week hitting a three-year high above $1.23.
ECB officials may not like the effect this is having on the competitiveness of eurozone exports. They also want inflation to rise and gain underlying traction so they can begin withdrawing crisis-era stimulus.
ECB policy maker Ewald Nowotny said on Wednesday that the euro’s recent rise is "not helpful" and that the ECB is monitoring developments. However, he and his colleagues will surely welcome the fact that the euro’s strength helps ensure the rise in inflation is incremental. This will allow the central bank to withdraw stimulus gradually, minimising the risk of an economic or financial market shock.
There are also dollar-based measures of oil that would still point to more benign inflationary pressures than first meet the eye. Brent may be up 30% in the past year, but the long-term average price is up far less. One long-term measure that smoothes out short-term volatility is the 200-day moving average, which is frequently used in technical analysis.
Brent’s 200-day moving average on Thursday was $55.70 compared with $49.07 exactly a year ago. That’s an increase of 13.5%, more than the 8% year-on-year rise in euro terms but far less than the 30% surge in nominal dollars.