"Oil at $140 Would Push Inflation to 5.8% and US Rates Up 0.5%P" - Oxford Economics

A recent outlook suggests that if an armed conflict between the United States and Iran sends international oil prices soaring to an average of $140 per barrel over two months, global inflation could surge to 5.8%, and the U.S. economy could approach recession levels. Due to rising prices, it is predicted that the U.S. and European central banks would each need to raise their benchmark interest rates by 0.5 percentage points.

On March 11, local time, the British think tank Oxford Economics presented this forecast in a report titled "The oil price that breaks parts of the economy."

Oxford Economics analyzed the economic impact under three scenarios: an average oil price of $80 per barrel for two months (baseline scenario), $140 per barrel (worst-case scenario), and $100 per barrel (realistic scenario).

In the baseline scenario, global economic growth would decline by only 0.1 percentage points, and in the realistic scenario, the drop would be around 0.3 percentage points. However, in the worst-case scenario, the global economy would experience a major shock.

The following summarizes the key points.

Baseline Scenario (Oil at $80): Global Growth Falls by 0.1 Percentage Points

Oxford Economics' baseline forecast assumes that the average price of Brent crude in the second quarter drops to about $80 per barrel, then gradually returns to the pre-war baseline path. This is based on the assumption that, for two months after the outbreak of war, the volume of energy transported through the Strait of Hormuz is reduced to about half of normal levels. According to simulations from Oxford Economics' Global Economic Model (GEM), a $10 increase in Brent crude prices leads to a reduction of approximately 0.1 percentage points in global GDP growth.

However, in this war, oil prices could rise even further. The higher the spike in oil prices, the greater the economic costs due to secondary inflation effects, tightening across financial markets, and supply chain disruptions. Additionally, the correlation between the stock market and oil prices becomes stronger than usual.

Major central banks, concerned about inflation from soaring oil prices, would adopt hawkish (tightening) monetary policies, which would further shrink financial markets. Historically, oil price shocks have tended to widen corporate bond spreads (the difference between government and corporate bond yields, reflecting credit risk), inflicting temporary damage on corporate investment.

Rising oil prices also lead to increases in transportation costs, food prices, and prices of other goods, which in turn amplifies overall inflation and significantly reduces real disposable income, thereby weakening consumer spending. There is also an elevated risk of secondary inflationary effects that could influence medium-term inflation expectations.

Worst-Case Scenario (Oil at $140): U.S. Approaches Recession, Global Inflation at 5.8%

In the worst-case scenario, where oil prices average $140 per barrel for about two months, global GDP could decline by 0.7% by the end of the year, and mild economic contractions could occur in the United Kingdom, the Eurozone, and Japan.

In the United States, major economic indicators such as industrial production, personal income, consumer spending, and employment would deteriorate. While this may not constitute a technical recession, the economy could approach recessionary levels. (Generally, a recession is defined as two consecutive quarters of negative growth.)

Globally, surging energy prices and increased supply chain stress could push this year's annual inflation rate to 5.1%, which is 1.7 percentage points higher than the baseline scenario. On a quarterly basis, inflation could reach 5.8%, still below the 8.9% peak recorded in 2022 at the onset of the Russia-Ukraine war.

Inflation forecasts for each country are difficult due to factors such as the level of oil and gas inventories and government policy responses. However, U.S. consumer price inflation is expected to peak at around 5% in the second quarter of this year and fall to around 4% in the fourth quarter, which is 1.4 percentage points higher than the baseline scenario. In the Eurozone, consumer price inflation is also expected to peak at around 5% in the second quarter and remain about 2.5 percentage points higher than the baseline scenario through the end of the year.

Additionally, unemployment rates in both the U.S. and Europe are expected to rise moderately, while the pressure from declining real incomes due to high inflation will become more acute. Furthermore, with global average stock prices in the second quarter projected to fall by about 10% compared to the baseline scenario, this shock is expected to have a greater impact on U.S. consumer spending than on the U.K. or the Eurozone.

Major central banks would have no choice but to raise benchmark interest rates in response to rising inflation. The U.S. Federal Reserve and the European Central Bank are expected to raise rates by 0.5 percentage points this year, while the Bank of England is expected to increase its rate by 0.25 percentage points.

Realistic Scenario (Oil at $100): Global Growth Falls by 0.2 Percentage Points Compared to Baseline

A more realistic scenario than a shock-inducing oil price spike is that oil prices rise somewhat higher than initially expected in the second quarter. If oil prices average $100 per barrel for two months, the global economy would weaken compared to the baseline scenario, but a recession would likely be avoided. Global GDP growth in the fourth quarter would be 0.2 percentage points lower than the baseline scenario, and inflation is projected to rise moderately.

This content was produced with the assistance of AI translation services.