The building up of tensions in Iraq, following the problems in Ukraine, has emphasised the geo-political risks to global growth. Neither of these economies is big enough to influence global demand directly, but the potential negative fall-out could come from the effect on oil prices. The situation in Iraq in particular has pushed up oil prices, but the rise so far is not substantial enough to have a major impact on the economic outlook. The favourable global supply situation also suggests that oil prices will ease, once the situation calms down.
The situation in Iraq has pushed up oil prices, but the rise so far doesn't have a major impact on the economic outlook
Nick Kounis Head of Macro Research
Geo-politics back to the fore
Just as the unrest in Ukraine has come off the front pages, the building tensions in Iraq have risen to take their place. Off and on, geo-politics has raised its head as risk to the global economy over the last few years. As in the case of Ukraine, Iraq is not big enough to have any significant direct impact on global demand. To put it bluntly, whether these economies boom or contract has little impact on views on the world economic outlook. However, these geo-political developments do matter, mainly because of their potential impact on oil prices. The violence in Iraq, which is the world’s sixth largest producer of oil, has led to fears about a disruption of oil supply, pushing oil prices higher over recent days.
Rise in oil prices not yet a threat
Higher oil priced tend to be a negative for global growth. Essentially, when oil prices rise there is a transfer of wealth from net oil consumers to net oil producers. As oil consumers are more likely and quicker to adjust their spending behaviour to the change in income, the net result tends to be slower demand for a time. Estimates we have made in the past is that a sustained USD 10 per barrel rise in the price of oil, will depress global growth by around 0.3%. So given the rise in oil prices we have seen so far, the effect on global growth will probably be modest. In addition, we think the rise in oil prices is unlikely to endure. In a recent note, our oil analyst Hans van Cleef explains that the rise in the oil prices has been limited because the largest oil fields are located in the south of Iraq, while the epicentre of the problems are in the north. In addition, global oil supply is plentiful.
Other risks to global growth are easing
Other threats to the global economy that have kept investors up at night, look to be easing. For instance, the near term prospect of a hard landing for China’s economy, as the authorities attempt to rebalance growth and control financial imbalances, look to be receding. Data showed industrial production, and retail sales gained traction in May. Fixed investment slowed, driven by weak property investment, but this is consistent with the strategy. The manufacturing PMI rose in June. We think growth will be roughly in line with the government’s 7.5% target this year. Still, the challenge of achieving an orderly deleveraging remains a risk for the future.
Financial markets bask in Fed sunshine
The other risk that investors have been worried about at various times has been the possibility of a disruptive central bank exit from monetary policies unprecedented in their scope and aggressiveness. The concern has been that when the punch bowl goes, the hangover may be heavy. The Fed has recently managed this process rather smoothly. Last week, it further reduced the pace of its asset purchases, while communicating that the economy was rebounding, but that interest rates would remain low. Financial markets rallied on this message in contrast to the wobbles we saw last year, when a tapering of asset purchases first came into view. Again, this risk has not disappeared. It remains to be seen how financial markets will react when interest rates increases do come around the corner, but we suspect that as long as it is against the background of strong growth, it should not cause too much of a stir.
Disinflation is ending
One of the big trends of the last year or so has been a downward trend in consumer price inflation in most of the big economies around the world. That trend looks to be over. US and Chinese consumer price inflation has recently accelerated, helped higher by rising energy and food prices. However, core consumer price inflation is also on the up in the US, partly reflecting the recovery in growth and declining unemployment. Eurozone inflation has continued to come down, but we think that the bottom is not too far off now. The combination of higher global food prices and, in the near term, oil prices, will offset some of the downside coming from the weak economy. Over time, we expect the moderate economic recovery and decline in the euro to put some upward pressure on inflation. However, it is going to be a very slow process.