Inflation and oil, the thin black line

2 min. reading
Financial Education, Market news / 7 August, 2017

Daniel Luengo Advisory Department

After the crisis that broke out in the USA in 2008, central banks acquired an even more prominent role than they already had to keep their battered economies afloat. With interest rates at all-time lows, the major economies had to resort to non-conventional measures and put debt-purchasing programmes under way, those known as QE (Quantitative Easing). But we should stop for a minute to discover what leads such exceptional measures to be taken and to do so we must bear in mind the main mandates guiding central bank monetary policies. Although unofficially there are many variables that guide their decisions, the fact is that officially their main obligation is to keep prices stable with inflation at around 2%. As they are inversely related, falls in rates should foster an upturn in inflation, whilst rate hikes produce the opposite effect of slowing inflation. Due to the 2008 crisis, inflation worldwide pulled back sharply, forcing central banks to act by lowering interest rates and, when this proved insufficient, to resort to non-conventional measures. Now we know how important inflation is, we should pay attention to the main drivers guiding it. And it is here where we find one of its main components – oil. The following shows the close relationship between oil and inflation in the USA. GRafico_Bancos-centrales_inflacion_petroleo
With oil prices remaining flat, it seems rather difficult for inflation to return to an uptrend.
And this is why the pace of rate hikes the Fed is anticipating is even more surprising; and were it to be implemented, it could appreciate the dollar, pushing oil down and placing inflation under even greater pressure. The task before Janet Yellen is not an easy one; monetary policies need to be normalised to have tools available to combat future periods of instability, but at the same time with pressure on inflation that is just not taking off. The dilemma facing the Fed and how it resolves it will continue to be the main factor affecting market performances; therefore, active management of the situation may prove crucial to attain positive returns with low volatility in what is, to say the least, a complicated environment.