McGeever: Oil slide reduces dollar's inflationary bite
The rest of the world waits with bated breath for the inevitable bout of inflation imported from the United States. However, the sound you are hearing now may be a collective relief.
The dollar is at its strongest in more than a year against major rivals such as the euro and the yen, thanks to rising U.S. interest rate expectations. It's also at multiple-year highs against many emerging-market currencies: South Korea’s won?hit?a 17-year-low earlier this month.
A weak exchange rate increases the price of imported goods and materials, and especially energy and commodities denominated in dollars, on which all countries depend to varying degrees. The greenback's inflationary effect is now being offset by a steep drop in global energy prices triggered the U.S. Iran interim peace agreement.
It will be a great relief to policymakers around the world, especially in Asia's energy-importing nations that were caught in a vicious cycle of exchange rates and inflation. Inflation worries push the currency down, increasing price pressures and inflation expectations.
It may be that they are closer to breaking out of this loop than what they thought a few short weeks ago.
OIL DISINFLATION
The spike in energy prices caused by the?Iran War' is likely to disappear just as quickly as it appeared.
Energy traders are feeling confident to lower prices as the 60-day negotiating window for U.S. - Iran peace talks has begun and oil shipments across the Strait of Hormuz have increased.
Brent crude futures closed at their lowest level since the outbreak of hostilities in late February, a 45% drop from wartime prices. Brent is below $80 a barrel and on the decline, while U.S. Crude looks set to reach $70 in a short time.
The price of oil is now a fraction of what it was only a few months ago when the price was over $100. Talks about $150 were common. Oil is nearing the point where it will be able to reverse its inflationary effect from the past year. The year-on-year difference in U.S. Crude?futures briefly went negative on Monday.
'MATERIAL CHANGE'
This rapid shift is helping to temper expectations of inflation globally and offset the impact of a strong dollar.
The adjustment in Europe is especially noticeable.
Nomura Capital Markets and RBC Capital Markets revised their European Central Bank forecasts on Tuesday, both removing the quarter-point hike from their estimates. Nomura expects to see two rate hikes over the next few months. RBC is calling for only one.
RBC's economists noted that the euro zone's inflation dynamics may mean-revert relatively quickly.
This already seems to be happening. The market-based inflation expectation, as measured by the one-year euro-zone inflation swaps, has dropped to 2.45%, from almost 3.90% a few months ago. And the five-year rate is now at 50 basis points below the ECB’s 2% target.
In Britain, too, the rate of inflation swapping for two years - which is a major factor in the pricing of fixed-rate mortgages - has returned to its pre-war level. UK rate futures are only pricing in one Bank of England interest rate hike for this year compared to three just a few months ago.
RELEASING PRESSURE
The pressure on countries to tighten their policies or intervene in FX markets is decreasing, even though crude prices are falling.
It may explain why Japan, who imports 90% of its electricity, doesn't intervene to support the yen which is hovering near a 40-year high at 162 per dollar.
This is lower than the levels that triggered multiple rounds in recent years of record-breaking yen buying intervention, including the most recent in April when the dollar rose above?160.
Brent crude, however, was above $125 per barrel at the time. Satsuki Katayama, the Japanese finance minister's latest threats to intervene would be more credible if oil was not below $75.
A number of central banks have taken action to reduce inflationary pressures. The ECB has raised rates, as have the Reserve Bank of Australia, Norges Bank and Norges Bank. Some emerging economies have taken drastic measures: Bank Indonesia raised rates in an emergency, Central Bank of Sri Lanka increased by 100 basis points last May, and Reserve Bank of India intervened frequently to support the rupee.
The 'pressure valve' has now been opened, giving policymakers the breathing space they need.
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(source: Reuters)
