Energy price offset to ongoing financial crisis
Monday, September 15, 2008 at 02:52PM
Simon Ward

Last week the US authorities rescued Fannie Mae and Freddie Mac, judging them “too big to fail”. This week the authorities have refused to bail out Lehman, on the basis that the firm’s failure is unlikely to trigger a systemic crisis. These judgements are defensible.

The risk of Merrill Lynch being the next domino to fall has been removed by its purchase (at a premium) by Bank of America. With the Fed ready to supply unlimited liquidity against an expanded range of collateral, including equities, fears of financial Armageddon are overdone.

Credit conditions will remain tighter for longer, with negative implications for the economy. However, lower energy prices will provide some offset – global headline inflation is about to fall sharply, boosting real incomes and creating scope for central banks to cut interest rates.

Based on recent crude oil and natural gas prices, the annual change in the energy component of the US consumer price index may fall from +29% in July (August numbers are released tomorrow) to -10% in early 2009 – see chart. Assuming no change in non-energy inflation, this would push headline CPI inflation down from 5.6% in July to about 2% by early next year.

In the UK, CPI inflation is likely to peak at about 4.8% in September before embarking on a steady decline. With wage settlements stable, money growth weakening and the economy stagnant, the MPC should be able to cut interest rates either next month or by November at the latest.

Article originally appeared on Money Moves Markets (https://moneymovesmarkets.com/).
See website for complete article licensing information.