Commodities | Mar 14 2011
– Magnitude, speed and duration of higher oil prices matter
– Growth impact of recent oil price gains expected to be mild
– Morgan Stanley forecasting US growth of 4.0% in 2011
By Chris Shaw
With oil prices surging recently, Morgan Stanley notes investors are again questioning just how sustainable is the US economic expansion. The concerns appear justified, as Morgan Stanley suggests a rough rule of thumb is a sustained US$10 per barrel increase in the oil price would cut growth by about 0.3% this year.
In the view of Morgan Stanley, the potential threat from any energy shock is likely to remain mild unless there are additional supply cuts and oil prices move significantly higher. At present, Morgan Stanley is forecasting US growth of 4% in 2011 and the broker sees a number of factors in support of retaining this view.
Looking at energy shocks in general, Morgan Stanley notes the magnitude, speed and duration of any shock all make a difference. Price increases due to stronger demand generally have little impact on growth as they reflect strength in the economy.
In contrast, price hikes resulting from a shock to supply are a different story, as such shocks both depress growth and boost inflation. In the current environment, if prices decline somewhat in the next few months Morgan Stanley sees little impact from current high prices, but if prices were to remain at current levels there is scope for 0.4-0.6% to be cut from US GDP growth this year.
This is because a supply-driven change in energy prices acts like a tax hike in that discretionary income is drained from consumers. This means a transfer of wealth to oil producers, so the effect on global growth will depend on how energy producers spend this wealth.
As all energy price hikes mean income is transferred from consumers to producers this means duration is also of importance notes Morgan Stanley. The energy price shock post Hurricane Katrina was temporary and so there was only a short-term impact. The 1970s oil shock was more sustained, meaning more serious and long-lasting implications.
What makes the current situation different to the 1970s according to Morgan Stanley is developed economies are less vulnerable, as energy efficiency has improved significantly. As well, energy as a share of US household budgets has fallen from 7% in the late 1970s to just over 5% now.
This reduced vulnerability is important as Morgan Stanley notes it is allowing central banks to maintain policies that are more supportive of economic growth. Also helping here is lower inflation, as while picking up core inflation in the US at present is still below 2.0%.
In terms of the present environment, Morgan Stanley notes demand has driven most of the increase in energy prices. Global oil demand in 2011 is forecast to grow by 1.2 million barrels per day to a record high of 88.6 million barrels per day, while non-OPEC supply is forecast to fall by around 380,000 barrels per day.
A more resilient economy is another positive, as apart from weather disruptions expansion appears to be gaining in momentum and resilience as de-leveraging continues and as household balance sheets strengthen. Economic data through February also suggests a rebound in economic activity, supporting the view momentum in the economy is improving.
This trend should continue as Morgan Stanley expects economic policy in the US will remain supportive of growth, as no shorter-term change in currently accommodative policy settings are likely.
Morgan Stanley does concede the risk for oil prices is skewed higher at present, as spare capacity remains tight and any disruptions to supply are likely to push prices up significantly. Another minor threat to growth is Federal fiscal austerity, given the potential for disruptions to Treasury auctions and expectations of a protracted fight over the budget.
On the plus side, Morgan Stanley estimates if the full amount of cuts to appropriations proposed by the Republican Party were agreed to, which is not likely, there would still be only a minimal impact on growth this year.
Overall, Morgan Stanley sees no reason at present to adjust its 4.0% GDP growth forecast for the US this year, even given a higher oil price environment.
