I wrote in my first letter of the year, that there is nothing more dangerous than a consensus. I pointed in particular to the perfectly reasonable-sounding view that inflation would fall quickly this year.
The arguments make good sense at first glance (our banks are still deleveraging and the VAT increase will fall out of the numbers in Britain). But my point was that much of the inflation we have seen in Britain has not been demand- but supply-driven. It comes from the government (tax rises), from our weak currency and from the high price of imported energy.
Most analysts at the time were convinced that falling Western demand would keep oil prices down and energy cheap, and that would be enough to flatten inflation. I worried that geopolitical tension would push oil prices up. Iran was being more than usually obstructive and there was more trouble everywhere, from Syria to Nigeria and Kazakhstan.
So far, that appears to be exactly what has happened. The International Energy Agency (IEA) has “reason to believe” Iran has tested a nuclear detonation device. Iran says its uranium enrichment is all about peaceful energy. Israel is unconvinced. Confrontation looks possible.
So, last week, Brent crude hit $125. That’s up 15% since the start of the year and, while still below the all-time dollar high it hit in 2008, it is, as Prosperity Capital’s Liam Halligan points out, above those levels in both sterling and the euro. The general view is still that this doesn’t really matter. As the move is mainly political, it can be easily dealt with via a release from the US Strategic Petroleum Reserve (SPR).
But there are issues. First, it doesn’t work that well. As Graham Turner of GFC Economics says, the effect of the release of some crude last June “is open to debate”. Prices did fall, but it is hard to distinguish the SPR release from a rise in supply from Saudi Arabia and the escalation of the euro crisis.
However, this isn’t the only reason to doubt that tapping into the SPR will solve matters. There is also quantitative easing – which is forcing up hard asset prices as investors look for anti-debasement trades.
And, crucially, demand for oil is still rising fast. I talked to Halligan earlier this week and he makes the point well. In 2001, global oil use was 77 million barrels per day (mbpd). In 2011, it was 89.6mbpd – a rise of 16% in ten years. But by 2015, the IEA expects it to be 99.1mbpd – a rise of another 11% just in four years. Even in 2009, a particularly nasty year for the global economy, global oil use fell by only 2%.
It used to be that falling Western demand meant falling oil prices. But now that non-OECD demand counts for half of total oil demand, that no longer holds. Things will change if our long-awaited Chinese hard landing materialises. But until then I’d be wary of assuming cheap oil will save us from inflation.