BoA: $100/bbl Oil Is Coming and it’s Bad News for the Economy

There are three primary reasons why a higher oil price could be bad for the global economy.

Firstly, “large price moves tend to cause reallocation and uncertainty shocks, which slow growth, particularly in the short run,” BoA’s report opines. It goes on to say that volatile oil prices make it difficult for businesses to commit to spending decisions that hinge on the price of oil.

Second, the report notes that “purchases of oil typically have a larger marginal propensity to spend than producers.” As a result, any significant increase in oil prices may cause consumers to reduce their purchases of goods and services that are both the linked and not linked to the price of oil. On the other side of the equation, oil producers would see windfall profits if oil traded back above $100/bbl, which could drive additional capital spending wage hikes. However, the report notes that because “owners of public and private companies tend to be disproportionately wealthy” they have lower marginal propensities to consume, and may simply save rather than spend profits.

Third, countries that stand to lose a lot from higher oil prices have historically been much more systemically crucial to the global economy.

The biggest losers from higher oil prices are likely to be the Euro area, the UK and Japan:

“As discussed above, many of the large economies including the Euro area, the UK and Japan would be clear losers because they are oil importers. We estimate that growth in these countries would be depressed by 0.2-0.5pp next year. The impact in Japan is likely to be in the low end of this range because robust recent income growth has shored up household finances. By contrast in the Euro area and the UK, saving rates are already very low, leaving households without much buffer to smooth through the impact of a large oil shock.”

In comparison, the surge in shale oil production has left the US in a better position to handle the oil market shock than in the past. The same appears to be true for Australia where a recent ramp up in LNG production means higher oil prices will “now have a positive impact on terms of trade.”

Overall, Bhave and Harris believe $100/bbl could take two tens off global growth in 2019 — not a significant impact overall, but considering where the hammer will fall hardest (EU and UK), the knock-on effects could be substantial.

This article originally appeared on ValueWalk Premium

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