More Inflation Is on the Horizon As Oil Prices Climb

Number of the Day: The most relevant or interesting figure in personal finance

NOTD - 0.4 Percentage Point

That’s how much the inflation rate would increase for every $10 rise in the cost of a barrel of oil, according to estimates by BMO Capital economists.

Oil on Tuesday was already at about $92 for a barrel of West Texas Intermediate crude, its highest level since 2014, and it could go higher, especially with recent tension between Russia, one of the world’s largest oil producers, and Ukraine. If BMO economists are correct, the 7.5% inflation rate we saw in January, a 40-year high, could move up to nearly 8% if a barrel of oil tops $100. 

Increased demand for oil this winter has already pushed oil prices higher. More energy was needed to heat homes because of exceptionally cold weather, and travelers, worrying less about the omicron variant of COVID-19 than before, were using more fuel to get around. At the same time, the Organization of the Petroleum Exporting Countries and other oil producing countries (OPEC+) have been limiting their production and keeping oil inventories low, which has kept prices high.

Adding to that mix is the escalating situation between Russia and Ukraine, where Russia has been gathering troops at the border for months. On Monday,  Russia said it would recognize what it called the “independence” of two breakaway regions in the eastern part of Ukraine and that it would move troops into those regions as a “peacekeeping” mission. The U.S., the U.K., and some other nations took this move as an aggression and imposed sanctions on Russia. Germany halted certification of a pipeline that would supply natural gas directly from Russia to Germany.

Because of Russia’s outsized impact on the availability of oil, any limits on the amount it supplies to other countries could send prices soaring. That, in turn, would increase the cost of anything else that depends on oil, either in its production or its transport. Gasoline, for example, is made from oil (oil accounts for about half the price of a gallon of gas), and goods of all kinds need to be moved from place to place.

All of that could add to inflation and impact economic growth as well.

“Higher energy prices famously act like a tax on consumers,” researchers at BMO wrote in a commentary. “The inflation impact, in turn, clips real disposable incomes by a similar tally. This hit tends to partially come out of savings and some from spending on other items.”

A $10 rise in crude oil prices has traditionally shaved U.S. GDP growth by about 0.1 percentage points, the BMO researchers said. 

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