FYI | Aug 01 2008
By Greg Peel
The world is currently watching on and willing the oil price to keep falling. The irony is that oil’s fall will only be driven by a drop in global demand, as US$25 has been wiped off the price of crude despite little movement in the US dollar against major currencies. A drop in demand, in turn, can only be driven by a weakening global economy.
Australia is willing the oil price to fall as well, and the government and RBA would be among the most enthusiastic. For Australia is beginning to see a round of wage claims which are directly related to the burgeoning cost of fuel and food. The cost of food is directly linked to the cost of fuel – weather notwithstanding – through both transport costs and the global ethanol push. The RBA has been trying to slow local demand, but despite localised monetary policy the only way inflation can come down is if the price of commodities fall (which would also ease the terms of trade) and workers abandon the need to push for higher wages.
Recent very weak economic data in Australia have, however, suddenly thrown up the possibility that the RBA may have pushed too hard. But the most difficult economic climate a central bank can ever face is one of stagflation – where economic growth slows but inflation rises – for under normal circumstances one factor calls for a rate cut and the other a rate hike.
The US Fed has the same problem, only worse. Having cut its cash rate from 5.25% to 2% to save the US, and the world, from financial disaster, the Fed has had to face the reality that its actions have also helped to drive global inflation. There is as yet little relief for the financial sector, which would dearly love another rate cut, but persistent inflation is currently preventing one.
The European Central Bank, by contrast, made no move to cut its rate as the credit crunch unfolded and last month increased from 4.00% to 4.25% to a seven-year high. The move came as the oil price was running amok, and received howls of protest from Europe’s export industry. Since the move, European business confidence has tanked.
But last night it was revealed European inflation grew from 4.0% in June to 4.1% in July – the highest level in sixteen years. It matched expectations, but there are growing fears the ECB will feel the need to make one more rate hike despite obvious signs of a weakening economy. What the ECB has done in the meantime is “urged” workers not to make pay claims, which I’m sure will be effective given European unions are such a right-wing bunch – not. However, once again it’s all eyes on that oil price. Economists agree that a wage-price spiral is more concerning than an economic slowdown.
As well as the inflation increase, Europe suffered an increase in unemployment in July to from 7.2% to 7.3% – slightly ahead of expectations. This was the first increase in three years. If the ECB is terrified of wage claims, you can see why the RBA has the same fear given Australia’s unemployment level is in the fours. But at the same time both are suffering from a collapse in business confidence – in Europe’s case the last reading was the worst since 9/11.
Nevertheless the ECB is maintaining that European economic growth remains “sound” at 1.8%, down from 2.7% in 2007. It is expecting 1.5% in 2009, and has declared that such numbers still give it “room to manoeuvre” on monetary policy, which doesn’t bode well.
It doesn’t bode well because the US dollar has recently found some level of stability against the euro, even though last night’s inflation result caused the greenback to slip a bit once more. Were the ECB to raise again, and the Fed not to as it tries to deal with Fannie & Freddie and a multitude of woes (last week saw the US regional banks accessing the emergency facility at record levels, and the investment banks are back with their hands out as well) the the US dollar would slide, putting upward pressure on the oil price.
What is a poor central banker to do? The Bank of England really had no idea this month, as its committee was spilt three ways between those wanting a hike, those a cut, and those wanting to stay on hold, which the BoE ultimately did. The Swiss central bank has also kept rates on hold since late last year, despite enduring its own fifteen-year high inflation.
The Fed meets this month next Tuesday night, and once again is expected to remain on hold. A falling oil price has eased the pressure to hike, while ongoing financial troubles are again suggesting a cut might be helpful. The RBA will have already have met and decided on Tuesday local time, and despite a bout of very weak data will not likely make any moves to cut just yet.
So let’s keep cheering that oil price.
