Turmoil in the Middle East has helped to push the price of oil above $100 (R688) a barrel for the first time since the credit crisis. This has implications for global inflation, but the observation that each of the recessions in the last 40 years has been preceded by an oil price spike should make investors even more concerned.
Indeed, the 2008 recession looks to have been precipitated in part by the squeeze on real incomes induced by a rapid increase in oil and food prices, combined with policy tightening designed to fight the resulting acceleration in inflation.
To help us understand how damaging the current rise in the oil price might be we can feed it into our own leading economic indicator of global growth and stress-test the results.
This indicator takes information such as commodity prices, monetary policy settings, measures of economic slack and credit availability, which are available now, but which affect the economy with a lag. Together, these measures can give us some indication of the likely direction of growth over the next year or so, and estimate the probability of a recession.
This is not an attempt to forecast the future, but rather to see the potential consequences of the changing economic environment.
So far the rise in the oil price has been more muted than in 2008. It is, however, up by over 50 percent in the past year, and food inflation is even worse than back then.
Both elements are beginning to push headline inflation higher and will undermine consumer purchasing power this year, especially in the world’s developing economies.
Our leading indicator suggests that this effect should be enough to push global growth back below trend in 2012. Other components of the model remain more positive, and certainly global monetary policy remains very loose, especially in the developed world, which should continue to support economic activity.
That said, policy is slowly being tightened and is also somewhat counterproductive, being one of the factors driving commodity prices higher through stronger growth and asset price inflation.
Using the current oil price, our indicator estimates an almost one in six probability of a recession next year, up from very little chance a few months ago.
To put this into perspective the estimated recession probabilities were around 30 percent to 40 percent about 12 months ahead of the 1990 and 2001 recessions and more than 70 percent before the 1975, 1980 and 2008 recessions.
South Africa, as part of the global economy, is also vulnerable. A rising oil price, aside from having a negative impact on headline inflation numbers, would also be bad for South Africa’s terms of trade if it accompanies a slowdown in global growth.
In all likelihood, if the developed world were to slip back into recession, South Africa, as one of the emerging economies that is operating below trend, would also likely approach, if not dip into, recession.
Unfortunately, our commodity analysts see a real possibility that oil prices could rise further, perhaps to $150 a barrel. Putting this number into our indicator raises the probability of a recession in 2012 to about 25 percent, still below the levels that have generally been followed by an economic contraction.
Looked at another way, our analysis suggests that the potential for a sharp slowdown in global growth is increasing and such an outcome would be very likely if oil continues to rise, but offsetting factors should prevent this from becoming a full-blown recession.
There is a clear risk, however, that this conclusion turns out to be too sanguine. In particular, excessive levels of leverage may mean that the global economy is now more vulnerable to a sharper downturn than in prior cycles, not least because there is less scope for developed governments and central banks to provide additional policy support. As a consequence, the likelihood of more aggressive quantitative easing next year and more inflation in the medium term appears to be high.
Unfortunately, courtesy of the law of unintended consequences, the US Federal Reserve and other central banks, by once again keeping monetary policy too easy for too long, are probably only making a commodity-induced downturn next year more likely and limiting their options for responding to it, if it comes.
For the global economy a mix of moderate growth and somewhat tighter policy seems more likely to foster a durable expansion than an aggressive effort to stimulate growth at any cost.
The Chinese appear to have understood this, but Fed chairman Ben Bernanke and others have not, and that worries us.
John Stopford is the joint head of fixed income at Investec Asset Management.