Oil prices are going up again, threatening to increase inflation once more. This goes against the central banks’ plan of cutting interest rates this year.
After months of a bearish trend, oil prices started rallying again amid supply restrictions and geopolitical tensions. Brent, the global benchmark of oil prices, broke $90 per barrel, creeping closer to the $100 psychological level. Brent prices have been relatively inexpensive since October 2023.
The supply shock in the oil market is taking place on several levels, a perfect storm of geopolitical events coming together.
First, tensions in the Middle East keep rising, with Israel and Iran once again at each other’s throats. Houthi attacks on oil shipments in the Red Sea continue almost unabated, with most shipping companies deciding to circumnavigate Africa for safety.
The United States, the world’s largest oil producer, will likely reduce crude extraction in 2024 as incumbent President Joe Biden seeks reelection. The Biden administration was heavily criticized by US environmental groups (a large base of Democratic voters) for its record oil production.
Mexico slashed oil exports too in an effort to boost its domestic industry. Mexican President Andres Manuel Lopez Obrador pledged to decrease oil prices in the country, but that comes at a price for oil supplies on the global market.
Combined with increased sanctions on Russia, which now finds exporting its oil more difficult than ever, and OPEC+ voluntary production cut, the perfect storm of rising crude prices is complete.
Chain effects
However, rising oil prices entail an increase in inflation. Western economies have been battling high inflation for over two years, making it a major point in Biden’s electoral campaign.
In the European Union, inflation is moving towards the 2% target set by the European Central Bank. The latest reading showed a 2.4% inflation in March.
In the United States inflation remains sticky, mostly because of continued spending by American consumers, more than the Federal Reserve expected. Consumer prices leaned upward in February, going to 3.2% from the previous 3.1%.
The central banks of both economies have been debating if and when to start cutting interest rates, which remained at record-high levels for months now. Both the ECB and the Fed, however, show caution and are delaying the first rate cut (also known as a “pivot”) as much as possible.
The Fed pledged a 0.75% cut in 2024 starting in the second half. To confirm it, however, it will need to analyze inflation data in the coming months.
The ECB is also considering a late cut, mostly because service inflation remains too high at 4%.
But rallying oil prices may disrupt these plans, showing that the battle against inflation is far from over. And in a year of elections in both the EU and the US this could have far-reaching effects.
