Oil: Knock-on effects of the forecasting error for prices to stay

Patrick Artus, Research Analyst at Natixis, explains that it is very likely that the oil price will rise markedly in the next few years, due to the rapid increase in demand and the fall in supply resulting from underinvestment in oil exploration-production since 2015.

Key Quotes

“This rise in the oil price is absolutely not anticipated, which creates a series of forecasting errors regarding:

Inflation;
Growth;
Monetary policies;
Long-term interest rates.”

“Many knock-on effects

The fact that the very likely rise in the oil price is not anticipated has a large number of knock-on effects.

(1) Erroneous inflation expectations.

(2) Erroneous growth expectations. In the United States, a rise in the oil price has a positive effect via its effect on the energy sector. In the euro zone, a rise in the oil price reduces growth by reducing real wages and domestic demand; the opposite happened from 2014 to 2016 due to the fall in the oil price.

(3) Monetary policies. As we have seen, the lack of anticipation of a rise in the oil price leads to a lack of anticipation of a rise in inflation, and therefore a lack of anticipation of a significant rise in short-term interest rates.

(4) Long-term interest rates. As a result of the lack of anticipation of inflation on the one hand and the lack of anticipation of a rise in short-term interest rates on the other hand, any significant anticipation of a rise in long-term interest rates has been eliminated.”

“We are convinced that oil price forecasts will have to be revised sharply upwards. This will be a major shock, leading to an upward revision of expected inflation, short-term and long-term interest rates and growth in the United States, and a downward revision of growth in the euro zone.”

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