Oil production cuts, weaker dollar mean higher US inflation is on the way
US inflation is the dog that has persistently failed to bark in recent years, but a combination of circumstances may mean that 2018 is the year that changes. One catalyst might be a decision to extend oil output cuts when the Organisation of Petroleum Exporting Countries (Opec) meets on Thursday in Vienna.
Currently Opec members, along with Russia and nine others, are committed to restraining oil output by some 1.8 million barrels per day until March next year. The expectation is that the production curbs will be extended by either six or nine months.
“The targets on rebalancing the market have not been reached,” Russian energy minister Alexander Novak said on Friday. “Everyone supports the extension, so that the targets are finally reached.”
While any rise in the price of oil would of course benefit oil producers, it adds to the costs of economies that rely on imported energy, such as China, and ultimately acts as a tax on consumers globally through the price-inflation channel.
Of course US oil producers, notably in the shale energy sector, would benefit from an oil price rise but the average American consumer would lose out, especially if the increase in the price of crude started to push up the cost of manufactured goods including those imported into the United States, most notably from China.
While data from the US Commerce Department shows the country’s trade deficit with China shrank to US$34.6 billion in September from August’s US$34.9 billion, over the first nine months of the year the cumulative figure was US$273.8 billion compared to US$257.6 billion for the same period in 2016.
To the extent that the scale of that trade deficit mirrors the attachment of the American consumer to goods manufactured in China, it also reveals a potential conduit for inflation to be imported into the United States if the prices of those imports from China start to tick up in US dollar terms.
China’s National Bureau of Statistics revealed on November 9 that inflation at the factory gate is on the rise. While analysts had forecast a 6.6 per cent increase in October, producer prices (PPI) actually increased by 6.9 per cent year-on-year.
“Inflation in China is worth monitoring,” wrote Stephen Li Jen of London-based Eurizon SLJ Macro on Friday, noting the “dramatic recovery in PPI inflation this year, from -6 per cent two years ago to +7 per cent now” and wondering if the “latest inflation prints point to elevated PPI inflation, with the risk that, sooner or later, China may experience cost-push inflation.”
As Jen points out, the rise in China’s PPI partly “reflects the recovery in oil prices,” so a further uptick in the price of crude as a consequence of the Opec meeting could accentuate matters, particularly as China is set to become even more dependent on imports for its oil in coming years as domestic production falls.
A five-year plan for 2016-2020, published by China’s National Development and Reform Commission in January, forecasts domestic crude production to fall by 7 per cent by 2020.
If the demand/supply balance for crude oil helps to sustain a higher price per barrel in the next few years, China’s export sector may have to pass on some or all of their higher energy costs to their customers. Their prices may have to rise.
Of course, in the case of the United States, if the dollar is strengthening against other currencies, the higher purchasing power of the greenback in, for example, yuan terms, would offset the effect of higher yuan-denominated price rises. But imported inflation would derive from a weaker US currency.
And recently the US dollar has been weakening, trading at a near two-month low versus a basket of other currencies on Friday, following a week that saw the minutes of the US Federal Reserve’s last meeting say that “many” of the participants observe “that continued low readings on inflation … might reflect not only transitory factors, but also the influence of developments that could prove more persistent.”
A rise in US inflation could emerge if an extension of the Opec/Russia output curbs prompts an uptick in oil prices when China is already experiencing higher factory-gate inflation and the US dollar is trading on the weak side.
It would be ironic but the US inflation dog could start barking more loudly next year just as the Fed has started to think that bark had become more of a whimper.