Tuesday 20 March 2018

Oil slump and Fed rates rise are good news - but with a sting for Ireland

The slump in oil prices is putting more money in consumers’ pockets, while Janet Yellen’s bullish Federal Reserve is reflecting a strengthening US economy. Photo: : Jasper Juinen/Bloomberg
The slump in oil prices is putting more money in consumers’ pockets, while Janet Yellen’s bullish Federal Reserve is reflecting a strengthening US economy. Photo: : Jasper Juinen/Bloomberg
Janet Yellen, chair of the US Federal Reserve. Photo: Andrew Harrer/Bloomberg

Jeremy Warner

It is hard to recall a time of such conflicting signals from the world economy. Oil and commodity prices are plummeting, promising cheaper fuel, but forcing crippling retrenchment on resource-producing companies and nations.

This might suggest deeply impaired demand, and a world economy that is heading back into recession.

In the US, on the other hand, the Federal Reserve is preparing for its first rise in interest rates since the onset of the financial crisis. Over in America at least, policymakers fear an economy that needs reining in.

Meanwhile in Europe, policy is heading in the other direction, with the European Central Bank cutting its deposit rate to minus 0.3pc and promising to extend further its programme of "quantitative easing".

What's going on here? Divergence such as this usually presages rough financial seas ahead - there will be busts, possibly of entire countries, as the world adapts to higher US interest rates - but perhaps surprisingly, the overriding message is broadly positive.

This is not to underestimate the risks of another recession, but merely to state what is not immediately obvious.

Disentangling the signals, we find a world economy which is in all likelihood pulling further away from the abyss rather than heading back into it, at least for now.

First the oil price. Contrary to what you might expect if the economy were about to take another bath, demand for oil is in fact rising, not falling.

Bank of America estimates that global demand has increased by around 1.8m barrels a day over the past year, the second highest rate of increase in 10 years. There is no mystery here. Low prices generate their own demand. China, in particular, has been using the opportunity of cheap oil to stockpile reserves.

The bottom line is that low oil prices are less a reflection of depressed demand as a glut in supply, caused in part by the expansion of American shale, but turbo-charged by Saudi determination to stifle these new sources of competition at birth by continuing to produce at full throttle.

In the past, Saudi Arabia would, in league with other members of the Organisation of Petroleum Exporting Countries (Opec), have cut production to support prices. Now the cartel has stood on the sidelines, not withstanding howls of pain from some poorer members.

By doing so, Opec has delivered a giant stimulus to big consumer nations, putting more money in people's pockets for discretionary spending and reducing overall inflation rates virtually to zero. This in turn has enabled real wages to start rising again after the long post-crisis hiatus. In economic parlance, the world economy is enjoying a massive "positive supply-side shock". The time to start worrying is when oil prices bounce back up again.

The story for other commodity prices, and in particular base metals, which are similarly plumbing post-crisis lows, is an entirely different one. Mining is perhaps the most cyclical industry in existence.

In good times, the big commodity producers invest with apparent abandon, opening up new capacity as fast as they can and piling on debt to pay for it.

The Chinese development story created one of the biggest and most prolonged booms ever, a so-called "super-cycle", the like of which had not been seen since European and Japanese post-war reconstruction.

Oddly, given their experience, producers began to believe the boom would go on forever. Up went the cry "this time is different".

Warnings from the Chinese high command that it wouldn't - or rather that demand would abate as China moved from its development phase to a more Western-like model of growth based on service industries and household consumption - went largely unheeded.

Nevertheless, the speed of the downturn has taken most observers by surprise. Producers are being forced to come to terms with what may be permanently reduced levels of ongoing demand. The big bulge has been and gone.

This is plainly very bad news for resource-rich countries, but for already industrialised nations, it makes little or no difference. And if it also means China ends up consuming more high-value-added Western services and goods, it is a positive boon. Some of the imbalances which have been at the heart of Western economic travails should begin to ease.

With unemployment back to 5pc, higher interest rates make obvious sense for the US. With unemployment at 10.7pc, it makes just as much sense for the Eurozone to be going the other way and easing further.

Whether it also makes sense for Ireland, which is expected to record growth of an astonishing 6pc this year, is another matter. Membership of the euro seems to have condemned Ireland to permanent boom and bust.

Mixed signals yes, but ones that seem to point in a roundabout way broadly in the same upwards direction - for a while, at least. Enjoy it while it lasts.(© Daily Telegraph, London)


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