RIYADH, 18 October 2004 — Oil prices are quickly closing the gap with its all-time high of $80 a barrel, inflation-adjusted at current dollars. They touched a new record of $55 a barrel this Friday. Given the upcoming US election and the January Iraq election, we expect that oil prices will rise further — probably touching $60 a barrel — before they go down, if at all.
Signs are emerging that it is beginning to bite. We know that the global economy is not as dependent on oil as it was in the early 1980s, when that record was made. The global economy is now much more oil-efficient. Interest rates are near record lows and inflation is nowhere to be seen. We have heard from one major economy spokesperson — Alan Greenspan — that oil is not yet a big concern. The US Fed’s chairman said on Friday that record oil prices are beginning to impact the US economy but he is not concerned. He said that so far this year, the rise in the value of imported oil, essentially a tax on US residents, has amounted to about 0.75 percent of GDP — not a material impact yet, according to him.
Europe, Japan and the emerging countries are most heavily dependent on oil. Japan, for example, imports all the oil it needs. Oil prices have risen by $20 in the past four months alone, and it just seems well nigh impossible that the oil-dependent countries are not beginning to hurt. The president of the European Central Bank (ECB), Jean-Claude Trichet, warned after the ECB’s rate setting meeting last week that high oil prices were creating uncertainty about Europe’s economic growth outlook; however, he remained confident that recovery was on track and inflation would ease next year.
The woes of the global financial markets were magnified by mixed economic data from the US, suggesting that the recovery is still not on a firm footing. US consumer sentiment sank to its lowest level in 18 months in early October. The University of Michigan consumer sentiment index dropped to 87.5 in early October from 94.2 in September. The drop was a big surprise as markets were expecting it to be 93.9.
Retail sales, on the other hand, surged in September, rising1.5 percent, as auto sales recorded its fastest growth since October 2001. Industrial production was less than expectations (0.1 percent vs. 0.3 percent growth) in September while the weekly initial jobless claim rose to an unexpected 352,000 vs. market expectation of 340,000.
Weakness in the international front was evidenced in the US trade deficit number, which came out higher than expected (-$54 billion vs. -$51.2 billion).
On the domestic front, SAMA’s (Saudi Arabian Monetary Agency) latest data show that bank holding of government bonds fell to SR150.7 billion in August, after reaching a peak of SR159.7 billion in March 2004. The drop is not unexpected given that the huge oil revenue this year has reduced the government’s need for debt financing. SAMA has also reduced the tap to banks since July and lowered the yields it offers on the bonds, thus making them less attractive going forward.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)