By Lucy Raitano
LONDON (Reuters) – Oil prices have risen about 16% so far this year, close to $90 a barrel, with supply concerns high due to rising tensions in the Middle East and retaliatory attacks on energy infrastructure between Ukraine and Ukraine. and Russia.
Investors are paying attention. After all, it was the rise in energy prices two years ago that helped drive up inflation and interest rates on a scale not seen in decades.
The International Monetary Fund on Tuesday described an “adverse scenario” in which an escalation of conflict in the Middle East would lead to a 15% jump in oil prices and higher transport costs, which would increase global inflation by about of 0.7 percentage points.
Shortages in oil supplies and higher prices were supported by reduced production by the oil-producing group OPEC and other major oil producers.
Morgan Stanley raised its third-quarter Brent crude forecast by $4 per barrel to $94. With oil prices expected to remain elevated, we look at the fallout for world markets.
1/ INFLATION CLOCK
After inflation in the US was higher than expected for the third consecutive month in March, the specter of inflation remaining higher returned with bets on interest rate cuts drastically reduced.
Lower energy prices have been a key driver of lower inflation expectations recently. Higher oil prices are seen as a threat to this trend.
A key market gauge of long-term inflation expectations in the euro zone, which generally tracks oil, on Tuesday hit its highest level since December at 2.39%. The European Central Bank has an inflation target of 2%.
ECB chief Christine Lagarde said on Tuesday that the new turmoil in the Middle East has so far had little impact on commodity prices. Oil, although close to recent highs, has eased a bit this week.
Still, the ECB said it was “very attentive” to the impact of oil, which could harm economic growth and increase inflation.
Zurich Insurance Group chief markets strategist Guy Miller said economies can survive, and producers are reasonably happy, when oil is around $75 to $95 a barrel.
“But if we saw that go up, yes, that would be a concern from both a growth and inflation perspective,” he said.
2/ GO ENERGY STOCKS
Energy stocks are clear winners from higher oil prices. The S&P 500 oil index and European oil and gas stocks remain near all-time highs.
U.S. oil stocks are up nearly 13% this year, outpacing the broader S&P 500’s 6% gain.
Ed Yardeni, founder of Yardeni Research, said a rise in Brent crude to $100 in the coming weeks was a possibility, recommending an “overweight” position in energy stocks.
Oil was last above $100 in 2022. It briefly spiked to around $139 after Russia invaded Ukraine, the highest since 2008.
“I believe you need to consider energy as at least a buffer in your portfolio in case oil prices continue to rise,” Yardeni said.
Barclays head of European equity strategy Emmanuel Cau has had an overweight position on European energy stocks since October, saying the sector tends to perform well in inflationary and stagflationary environments.
In contrast, Nordea CIO Kasper Elmgreen said he was negative on energy stocks because the costs associated with an energy transition have not yet been correctly priced.
“They (energy companies) will have to bear a much greater burden to reach the net zero target, and that is not reflected in the share price,” Elmgreen said.
3/ ROBUST DOLLAR
2024 began with expectations that the dollar would fall as inflation weakens and allow the Federal Reserve to begin cutting rates.
Instead, the dollar has risen 4.7% this year as bets on rate cuts are scaled back.
Higher oil prices could fuel dollar strength.
Bank of America said that while it remained negative against the dollar over the medium term, high oil prices meant the US currency had “upside risks”.
That adds to the pressure on economies like Japan that are struggling with currency weakness, keeping investors nervous about possible intervention to support the yen, which is languishing at 34-year lows.
“The yen and euro will see their terms of trade worsen as energy prices rise. This implies they will become weaker if energy prices rise,” said Colin Asher, senior economist at Mizuho Corporate Bank.
4/ FRESH PAIN IN
Higher oil prices for longer will also affect many emerging market economies, such as India and Turkey, which are net oil importers.
The Indian rupee hit historic lows against the dollar this week.
With oil priced in dollars, many importers are also exposed to higher prices caused by currency fluctuations.
Even in Nigeria, normally Africa’s biggest oil exporter, the devaluation of the naira currency has hit government coffers due to limited prices at gas pumps and a lack of local oil refining.
(Additional reporting by Natalie Grover, Libby George and Amanda Cooper; Graphics by Kripa Jayaram, Prinz Magtulis, Vineet Sachdev, Riddhima Talwan; Editing by Dhara Ranasinghe and Mark Potter)
