Many economists, including Alan Greenspan, have blamed a spike in oil prices this spring for slower economic growth and higher inflation in June.
But in case you hadn’t noticed, the spring oil-price spike has been nearly matched by an equally bad summer price spike. Many economists doubt the latest jump will have a similar drag on economic growth — though it could push inflation higher.
For 12 out of 15 days in late May and early June, oil was above $40 per barrel — and above $41 on seven of those days — while the average price of a gallon of gasoline jumped above $2 a gallon, a new record, for two straight weeks.
Oil prices fell steadily through June. But in the past 14 days, oil prices have been above $40 a barrel for 11 days, including six days above $41. Mercifully, gasoline prices haven’t returned to the $2 average mark, but they’re still much higher than earlier in the year and could breach $2 again shortly.
Higher energy prices act as a sort of tax on consumers who need gasoline to get to work and the mall and on companies who use oil products to do business.
So why shouldn’t the current oil-price jump hurt just as badly as the one in spring?
Keep an eye on inflation
For one thing, according to some economists, as long as prices don’t keep climbing, consumers can grow accustomed to higher levels.
“If gas prices are just holding steady and not increasing, and if incomes are rising, your gas bill is the same, and [consumer] demand can rebound,” said Steven Wieting, senior economist at Citigroup. “That’s the most likely scenario here.”
As for businesses, they’re much less sensitive to higher oil prices than they were, say 30 years ago, when oil-price spikes triggered brutal recessions.
Despite the higher oil prices, Tuesday brought reports of improving consumer confidence and retail sales in July, seemingly justifying the belief of Greenspan and other observers that the economy would shake off the earlier oil spike, even if prices are still relatively high.
“June’s swoon is indeed proving to be temporary,” said Sherry Cooper, chief economist at BMO Nesbitt Burns.
But if higher oil prices are here to stay, as seems to be the case, then higher inflation could be here to stay, too.
When crunching inflation numbers, economists like to strip out energy costs because they can be volatile and can obscure longer-term inflation trends. But if oil prices rise to a high level and then stay there, they eventually bolster inflation expectations and lead to higher prices overall.
“The fact that oil is remaining above $40 leaves me all the more convinced that core CPI will continue to climb higher, that we’re on the verge of having the annual rate break above 2 percent,” said John Lonski, senior economist and bond analyst at Moody’s Investors Service.
The core CPI, or consumer price index excluding food and energy costs, has been below 2 percent, on an annualized basis, since December 2002.
But it has risen fairly sharply this year, from an anemic 1.1 percent to 1.9 percent in June, and Greenspan and the Fed have started raising their key overnight lending rate to stem the flow of money into the economy and temper inflation risks.
The Fed has promised to take it easy raising interest rates, and Lonski and other economists believe it will.
Despite higher energy prices, labor costs — the biggest component of inflation — are still tame, and the Fed would likely prefer to avoid making a big stink in financial markets, the housing market and the 2004 presidential election with a more brutal rate-hiking campaign.
The dampening effect of oil
Still, even if consumers and businesses can largely shake off higher oil prices, few economists doubt they can completely ignore the pain.
For one thing, higher oil prices have put pressure on stock prices often this year and could do so for the rest of the year, according to Ed Yardeni, chief investment strategist at Prudential Equity Group.
“After rounding up all the usual bearish suspects to blame for the market’s disappointing performance this year, I’ve narrowed the problem to the price of oil,” Yardeni wrote in a note to clients Tuesday afternoon. “Investors fear that higher energy costs must eventually depress earnings growth.”
As a result, Yardeni cut his year-end S&P 500 target to 1190 from 1300 and cut his recommended stock allocation.
Higher borrowing costs, along with bloated energy prices and a weaker stock market make up a trifecta of trouble that could curb economic growth in the following year, according to a recent note by David Rosenberg, Merrill Lynch’s chief North American economist.
Rosenberg noted that, in every year since 1954 when equity prices have declined, the Fed’s overnight lending rate has risen and oil prices have climbed, the economy’s rate of growth has sunk by an average of 2.5 percentage points the following year. The exception was 1977, when economic growth actually improved the following year.
Though he doubted the rate of gross domestic product (GDP) growth would slow from roughly 4 percent in 2004 to below 2 percent in 2005, he said he does expect the rate of growth to slow to about 3 percent.
And quicker Fed tightening, along with oil prices above $45, would sink the rate of growth even more.
“A consensus-style 3.5-percent Fed funds rate,” he wrote, “coupled with oil moving to a $45-to-$50-per-barrel range — neither of which, by the way, forms our base case — would certainly do the trick.”