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Worker
walks past drilling rig at well pad of Rosneft-owned
Prirazlomnoye oil field outside Nefteyugansk
Thomson Reuters
Many economists would argue that there is a complex relationship
between oil prices and inflation, comprising of many differing
factors.
There seems to have been a calming of that connection since the
peak of the oil crises in the seventies, which saw rocketing oil
prices noticeably hiked inflation, but some patterns still remain
and are envisaged between oil and consumer prices.
Midway through 2014, the cost of a barrel of crude oil began to
fall, and a study last year by economist Alejandro Badel
and research associate Joseph McGillicuddy for the Federal
Reserve Bank of St Louis, revealed simulations of different paths
of inflation.
If oil prices rebounded to $100 per barrel in the first half of
this year, inflation would jump to 4.5 percent, and then fall to
around 2 percent in June next year.
Alternatively, if the cost of oil remained static at the current
spot price of $52 per barrel at the time of writing, then
inflation would jump up to 3 percent in January this year, then
be reduced back to the 2 percent mark by midway through next
year.
Conversely, if prices were to fall to $20 per barrel, then the
consumer price index would fall to a minus 1 percent level,
eventually settling at 2 percent in June 2017.
All three scenarios point to a shock effect of oil price
fluctuation, which eventually settles down into an even path.
The reality is that, through a year of volatile oil prices in the
United States, there is some evidence of an effect on inflation
rates.
An
oil worker steps over pipes next to a ChevronTexaco drilling
platform January 15, 2003 near the Saudi Arabian border,
Kuwait.
Joe Raedle/Getty
Images
Although, as oil prices were falling in the latter part of 2015,
inflation in the United States alone was actually increasing.
In January, when oil prices reached a nadir of $28 per barrel,
inflation slipped down to 1 percent in February from 1.4 percent
in January.
As prices increased and steadied as the year progressed, there
was only a 0.1 percent deviance from an inflation rate of 1
percent, between February and June.
Oil prices then began to slip again in July, and in early August
fell down to $41.80 bbl, the lowest that oil had been since
April.
Inflation slipped to 0.8 percent in July, and then oil prices
rebounded in August as OPEC talks over a possible reduction in
oil production became known. Oil moved up to just under $51 bbl
in August, before inflation figures in September confirmed a hike
of up to 1.5 percent.
In the United Kingdom, there was more evidence that the recent
increase in oil prices had an effect on inflation, removing the
windfall for motorists and consumers in general.
Prices rose to 1 percent from 0.6 percent month on month in
September, with the plummeting value of sterling since the
decision to vote out of the European Union, another major reason
for the inflation hike.
Inflation predictions are also a significant aspect of stock
market speculations.
For example, there was as a fall in breakeven inflation rates,
the difference between the nominal yield on a fixed-rate
investment and the real yield, on an inflation-linked investment
of similar maturity and credit quality, alluding to the United
States $28 per barrel price back in January.
These are measured using the premium paid for Treasury
inflation-protected securities, over standard Treasury bonds.
Over a longer period of time, oil prices may also have an effect
on inflation swap rates, a derivative which transfers inflation
risk, through an exchange of cash flows.
A study carried out by economists David
Elliott, Chris Jackson, Marek Raczko and Matt Roberts-Sklar for
the Bank of England, followed inflation swaps and the effect of
daily oil spot prices.
In a regression model, constant and lagged inflation swap rates,
were compared to current and changing oil spot prices, and
calculated the effect of inflation expectations over three years
and five years (5y5y).
The results from this model were from between January 2009 and
July 2015.
Over the duration of three years of inflation swaps there was a
significant effect, especially for the United States which jumped
up to 1.2 basis points.
And the Euro area and the UK experienced a hike of just under 1
and 0.4 basis points respectively.
Over five years the influence of the model dissipates in the case
of the UK, but it is still significant in the United States and
the Euro area.
The study reads: “The regression results imply that, for example,
a 10 percent fall in the oil price is associated with falls of
approximately 4 basis points in U.S. 5y5y and 2 basis points in
Euro area 5y5.”
Workers
stand near an oil drilling rig belonging to Petroamazonas at
Miranda Port in Tiputini
Thomson
Reuters
John Corrigan, principal of StrategyX, Pricewaterhouse Cooper’s
strategy consulting business, reflected: “Higher oil prices can
drive inflation for consuming countries, and most OECD countries
will calculate inflation with and without oil prices due to the
volatility.”
“However, given the energy content of most goods and services,
taking into account shipping, trucking, rail, etc, energy is a
significant cost component in most products.”
He added: “Timing and magnitude of these impacts can vary
depending on the relative state of the economy, and the ability
of producers to pass along the cost increases.”
“In terms of inflation driving oil prices, these effects are more
likely to be driven by what is causing the inflation – high GDP
growth and high consumer demand. Both of which will drive demand
for oil and thus oil prices.”
Corrigan went onto conclude that oil is a very global and liquid
commodity, thus prices are driven by global conditions more than
local conditions.
However, currency issues come into play when talking about local
market prices. Oil trades largely in USD, so any country, as in
the currently the post-Brexit UK, whose currency loses relative
value to the dollar will see costs per barrel go up.
This in turn is translated into inflation of all of the goods and
services with significant oil energy cost components
He continued: “As a commodity and basic need for most economies,
oil price increases are more likely to drive inflation than price
increases in elective purchases like cars. The ability of people
to increase or decrease consumption will impact the broader
inflation impacts.”
“For instance, the impacts on today’s economy is much less than
it was in the 1970’s due to greater energy efficiency in the
economy. Thus, demands on personal income will be lower during
price increases.”
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