Oil again

Juan Carlos Martínez Lázaro. Professor. IE Business School

10 February 2011

The rising price of oil threatens to scupper the ECB’s monetary policy by fuelling inflation, placing the Eurozone’s recovery in danger.

There are many explanations for the bullish rally that has taken oil to over $90/barrel, from the wave of arctic weather that is sweeping across Europe to the recent depreciation of the dollar. But the main reason lies in the forecasts of the recovery of the world economy, which will lead to an increase in the consumption of energy. Moreover, in view of a possible increase in consumption in the mid-term, speculation could push prices up in the short term and it would come as no surprise to see barrels rise to over $100 in the coming weeks.

And that will mean that inflation rates will continue to rise, as well as the inevitable feeling of anger each time we fill up at the petrol station. Although they have remained at reasonable levels (around 2% in the eurozone as a whole), they have increased significantly in just over one year, when what we were frightened of was the ghost of deflation. And if they keep rising, they could lead the ECB to a situation where it would have to alter its monetary policy earlier than anticipated to stop inflation squeezes, which would be particularly damaging for the eurozone´s present faltering recovery. The same happened in the summer of 2008, when the effect of inflation on the highest ever oil prices caused an increase in interest rates at a very delicate time for the European economy.

It is interesting to see that inflation risks that have not been caused by the large injections of liquidity made by the central banks or pressure from demand, but rather by oil, are again capable of affecting the recovery of the world economy.

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