Oil: Recent price developments affecting Eurozone inflation forecasts - Rabobank

Since the end of June, when tensions in the Middle East rose with Saudi demands on Qatar to sever its links with Iran, oil prices have steadily increased from around $45/bbl for Brent to around $62/bbl now, points out Elwin de Groot, Head of Macro Strategy at Rabobank.

Key Quotes

“Oil prices spiked at just below $65/bbl earlier this month, following the purge enacted by Saudi crown prince Mohammed bin Salman. Meanwhile, crude oil inventories have also come off their highs since March.”

“In terms of what the recent oil price developments mean for our oil projections, the first observation we would like to make is that our baseline forecast for oil prices has not materially changed. We were already forecasting levels of around $55-60 for Brent over the medium term (2018H2) in early July; our current view is a projected range of $60-65 for 2018.”

“In other words, the average expected increase is only around $5/barrel, or +8% compared with our previous forecast.”

“The second observation is that this oil price increase, to a certain extent at least, has been offset by a strengthening euro exchange rate. EURUSD was trading at levels of around 1.12 during the early summer period, hit a peak at just over 1.20 by mid-September, and has eased off to a range of around 1.16-1.18. So the rise in oil prices since end-June as measured in euros is slightly more modest (i.e. from EUR40 to EUR53/bbl). Moreover, since early July we have been raising our EURUSD forecast over the medium term by around 4%.” 

“Hence, as far as recent developments in oil and the foreign exchange rate are concerned, we are talking about a 4% net increase in oil prices (measured in EUR) for next year as compared to the views held four months ago.” 

“How does the recent development in oil prices affect our view on Eurozone inflation?

• Our models indicate that a 10% increase in oil prices (at around current levels) leads to a 25bp increase in consumer prices, most of which falls in the first 12 to 18 months.
• So in terms of what recent developments in oil and the currency mean for our inflation forecast, we note that a sizeable impact was already factored into it. Taking the +4% net change into account, we estimate that this would add around 0.1% to our baseline forecast for headline inflation in 2018. 
• Of course there could also be second-round effects that might amplify the overall impact on inflation. However, given the slow pass-through of spare capacity (unemployment, output gap) to core inflation, we believe this is still a limited risk at the current juncture. In fact, the recent core inflation print of 0.9% for October implies that our overall inflation projection hasn’t materially changed.”