We believe that the fall in the oil price is positive for the global growth outlook in the medium term. However, very large relative price swings can be quite disruptive in the short term as it takes time for the real economy to adjust. This is being expressed in increased financial market volatility and a substantial sell-off in certain asset classes, high yield bonds and emerging market debt (EMD) in particular.
EMD HC and Global High Yield affected by fall in oil price
Oil price decline is positive for global growth…
On balance, the oil price decline is positive for global growth. In essence, the drop in the oil price is a transfer of real income within the global economy, away from oil exporters which have a relatively large propensity to save. After all, they are sitting on an exhaustible resource and would like to consume the benefits long after their oil wells have dried up. Oil importers, by contrast, have a lower propensity to save, also because a lower oil price disproportionally benefits their low income consumers (for whom energy is a large part of the consumption basket). The net effect of falling oil prices will thus be a reduction in global excess savings and an increase in global consumer spending. A drop in the oil price acts as a tax cut for consumers and consumption represents the lion’s share of GDP.
We have to add to this that at the moment, it is far from clear that current oil price levels represent the “new equilibrium”. A supply reaction – in the form of production cuts – in the medium term is possible. This would cause oil prices to rise. A quick return to >US$100 levels is however not very likely.
…but could induce a decline in inflation expectations
Another consequence of the oil price decline is that inflation rates will move lower. To various degrees, this could also have an effect on inflation expectations. In the US and the UK this effect will probably be limited. Here we also see compensating factors such as the tentative signs of a pick-up in wage growth.
By contrast, in a depressed economy with persistent ‘lowflation’ – like the Eurozone and Japan – there is a clear risk that lower oil prices could help accelerate the downward slide in inflation expectations. The Bank of Japan has already reacted to this and if this should not prove to be enough it will not hesitate to do more in our view. The ECB is expected to react to this early next year. All in all, the oil price decline will thus probably be conducive to easier global monetary policy at the margin.