Oil price fears supplant eurozone worries
1 Apr 12
Sentiment about the world economy continues to improve. Oil has now replaced the eurozone as the main perceived threat to the world economy.
But the eurozone crisis has only entered a lull, not ended. Those are key messages from the March edition of EFIC’s newsletter, World Risk Developments.
“Aggressive liquidity injections by the European Central Bank plus a Greek debt exchange have eased fears that the eurozone crisis will escalate, ” says EFIC chief economist Roger Donnelly. “And better US data are stemming concerns about the American economy. Yet fears of an oil shock are growing. Crude oil prices have jumped 17% over the year to date. Markets aren't worried just about the drag on growth from expensive oil, but also about the prospect of military conflict with Iran.”
What's behind the recent rise in oil prices? “There seem to be three main reasons,” says Donnelly. “The first is brisk demand – regardless of stagnancy in the North Atlantic economies, fuel-thirsty countries like China and India continue to expand their oil purchases rapidly. The second is sanctions against Iran – importers are reportedly switching to other suppliers ahead of the start of EU sanctions in July; surprisingly, other buyers are not rushing in; and the result is a loss of Iranian oil from the market. The third factor is a growing fear of military conflict with Iran.”
“If conflict were to occur, oil prices could spike sharply higher and exert a powerful drag on economic growth, probably sending the world economy back into recession,” warns Donnelly.
Even if the oil price subsides, Donnelly expects the eurozone crisis to flare up again, because of a host of unresolved issues like large fiscal financing needs among troubled ‘Peripheral’ countries and the danger of self-fulfilling solvency crises as they struggle to recover and outgrow their debts.
“As we have seen before, these risks have the potential to curtail international credit availability and import demand, and thereby dampen world growth.”
According to the newsletter, there is also a risk of renewed US slowdown if oil market or eurozone tail risks surface. Even if they don’t, fiscal retrenchment through spending cuts, and even more importantly tax hikes, could act as strong drags on growth in 2013.
The newsletter concludes that the world economy seems to be accelerating swiftly from its December quarter soft patch. Better still, emerging markets continue to act as a powerful global growth engine. But there is also bad news. Even in the best case, growth is likely to be slower in 2012 than 2011. And downside risks predominate.
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