Falling oil price stokes inflation

What if the falling oil price will ultimately be the catalyst for global inflation starting to pick up? That statement is counterintuitive, a falling oil price is deflationary by its very nature, is the accepted principal. That is correct when one takes the falling oil price as a stand-alone measure, but if one looks at the secondary effects a falling oil price has, it may have inflationary implications elsewhere.

 

Much has been made of the fact that one needs to see wage inflation before one starts to see a rise in headline inflation. We take the view a falling oil price can be considered as a wage increase. The cost of fuel can be thought of as a tax, we all run cars and heat our houses so it’s a cost we must bear, just like income tax we have to pay it in the world we live in. If the oil price falls so does our effective tax rate, boosting our disposal able income, which can spend on less essential items boosting the economy overall.

 

From a corporate point of view the cost of oil is a direct cost, whether its transport or heating. A rising oil price is one of the principal historic causes of recessions, for the very simple reason companies are forced to cut costs elsewhere to combat the rising cost of fuel. On that basis one could logically suggest a rising oil price is ultimately deflationary in its impact.

 

 Logic would suggest that if corporation’s costs are falling, it too has more disposable income; either to invest elsewhere or to possibly give some of those much discussed and anticipated wage increases. It is quite possible that the employee will not only benefit from an effective “lower tax rate” but may at the same time receive an increase in salary.

 

It is probably fair to say that initially the falling oil price benefits will not be seen by the individual, and much will be made of the fact that for example the eurozone are now even more likely to face the prospect of deflation. This will lead central bankers will now feel even more confident about leaving interest rates where they are for longer.

 

So now consumers and corporates alike have ultra low interest rates and tax cuts, along with complacent central bankers if that does not start a true inflationary recovery it is hard to see what will. 

Posted on December 1, 2014 .