By Howard Schneider, Leika Kihara and Balazs Koranyi
WASHINGTON/TOKYO/FRANKFURT (Reuters) – An oil price war between Russia and Saudi Arabia is further confounding the world’s central bankers, adding worry over rising currency values in Japan and Europe and a potential blow to investment in the United States to an economic outlook already soured by the fast-moving coronavirus outbreak.
The decision by Saudi Arabia to raise oil production pushed prices down as much as a third overnight, a potential boon to consumers and companies with big energy bills, but a problem for central bankers worried inflation may fall even further below their targeted levels and add new stress in global financial markets.
While oil price swings are often dismissed among monetary policy officials as too transitory to influence their decisions, Saudi’s actions promised a more persistent drag on prices, with a sudden new round of volatility for officials to study in a key commodity market.
For the U.S. Federal Reserve, the oil price collapse means its efforts to support the economy with interest rate cuts may be blunted before they even take hold, and possibly prompt even more action.
“The drop in energy prices should prompt the Fed to be even more aggressive,” said Ryan Sweet, head of monetary policy research at Moody’s Analytics.
Fed officials said they hoped last week’s emergency rate reduction of half a percentage point, as well as subsequent cuts investors expect in coming weeks, would encourage business investment.
But a good share of U.S. capital spending is associated with the energy industry, and at the current level of prices investment in drilling and exploration has tended to ebb. While cheap oil also puts money in consumers’ pockets through lower fuel bills, and can encourage spending on other consumption, that may be less likely at a time of fear about the virus, and the potential expanded use of quarantines to combat it.
The plunge in prices, with West Texas Intermediate nearing $30 a barrel at one point, “will have a net negative effect on the U.S. economy as consumers save the windfall,” Oxford Economics senior U.S. economist Lydia Boussour wrote.
CURRENCY AND INFLATION TROUBLES
Central bank officials had already said they were prepared to act if the economic fallout of the coronavirus worsens, as it is expected to do if more widespread testing reveals a larger number of infections than currently estimated.
The unexpected turn in oil markets could reshape the speed or scale of some of those actions. IT also raise concerns about stress among smaller oil exporting nations, or in corners of the corporate bond market with heavily leveraged bets on energy producers.
In Japan, investors rushed to buy yen, triggering a spike in the Japanese currency and adding to concern about the near-term outlook for their export-reliant economy.
Japanese Finance Minister Taro Aso cautioned investors against pushing up the yen too much, and Bank of Japan Governor Haruhiko Kuroda signaled his readiness to ramp up monetary stimulus as early as next week to fend off risks from market volatility.
European officials may see the immediate impact of lower oil prices as helpful to growth. But if it leads to a steady rise in the euro or pushes down inflation it could also complicate choices for the European Central Bank beyond problems posed by the virus outbreak.
If oil prices remain depressed “inflation in the euro zone could fall to the psychologically important 0% mark in May,” Commerzbank (DE:) analysts estimated.
U.S. inflation expectations are already creating, another possible concern for the Fed. Following the oil price and equity market drops on Monday, bond market-based measures of estimated inflation in five years time had fallen below 0.75%, their lowest level since 2009.