>OIL & MONEY: Quantitative Easing(QE). Emerging Markets(EM) and Monetary Policy

■ Higher oil prices reflect both supply concerns and rising global demand
■ QE is adding to oil price increases as well by ‘turbo-charging’ EM growth
■ Higher oil prices will imply more monetary easing from the west but EM will respond by quantitative tightening


Oil prices are edging up again. Why are prices rising?
Western policymakers have been accused of stoking oil and wider commodity price rises through quantitative easing. We believe that oil price increases are still a function primarily of higher emerging market demand and supply side concerns especially related to Iran. Our analysis shows only limited impact of direct speculative activity on oil prices, but QE is playing a role in pushing oil prices higher as well by turbocharging
EM world growth.


What will be the impact of further oil price rises? The historical link between a slump in developed economy growth and lower oil prices globally has been broken, since emerging markets now account for nearly half of oil consumption. Higher global oil prices lead to a drop in nonenergy consumer spending in developed economies. In many emerging economies, the biggest threats are inflationary.


What should the policy response to higher oil prices be?
Developed world monetary easing has been ineffective to the extent that it has stoked oil price increases, resulting in an unfavourable growth-inflation trade-off. But we expect monetary easing including QE to remain the main response to oil price increases. The costs to slow growth are much higher than the risk of runaway inflation in an environment of high unemployment and low wage increases.


For a number of emerging markets, inflation will ultimately be the main concern, which will favour monetary tightening albeit unconventional tightening. The first line of defence is likely to be fiscal policy, in particular price controls and subsidies, with monetary policy aimed at preventing second round effects on inflation. In terms of fiscal health, it would seem that Asia is better placed than other regions to deal with an oil price shock.


Oil’s worth


Globally, the US and other economies seem to be showing signs of stabilisation, raising hopes that this year will be the start of a real period of recovery for the western world. But we’ve been here before, at the start of 2011 when the growth outlook seemed similarly rosy. That optimism faded quickly as the world economy was buffeted by the impact of the tsunami and earthquake in Japan but more importantly by the surge in oil prices that followed the loss of oil supply from Libya.


Undoubtedly, stable or falling oil prices in 2012 would be a boon, with inflation set to ease as the energy component falls out of the equation. This in turn, would allow authorities more room to focus on growth.


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