How falling oil prices could save the economy

Oil’s recent drop to the low $70s and brief dip in the $60 handle could open the door wider for major economies to avoid recessions.

Lower gas and energy prices suppress inflation, giving central banks more ammunition to cut interest rates faster. This, in turn, would support savings and boost household purchasing power.

Brent oil’s drop below $70 a barrel earlier this week may be bad news for the budgets of OPEC+ producers trying to manage supply and prices, but it is generally good news for the Fed and other central banks.

The sooner the Fed starts easing monetary policy, the sooner the benefits to the economy would trickle down, making the US economy more likely to achieve the so-called “soft landing” that policymakers have been trying to achieve.

Falling oil prices

Brent crude prices crashed earlier this week below $70 a barrel amid worries about global demand and OPEC’s second consecutive downward revision to oil demand growth estimates.

Signs of weak demand and weakening refining margins weighed on oil prices and market sentiment, prompting speculators and money managers to cut their bullish bet on oil futures to the lowest since 2011.

After last week’s selloff, prices steadied somewhat on Monday before falling 4 percent on Tuesday after OPEC cut its demand outlook in a second straight monthly report.

Brent crude oil prices fell below $70 a barrel and U.S. benchmark WTI Crude fell below $66 a barrel on Tuesday, with both benchmarks set for their lowest level since December 2021 by almost three years.

Inflation under control?

Oil prices at $70 or lower could reduce inflation rates and increase disposable income for consumers, analysts and bankers told Bloomberg.

“It’s very useful, especially for central banks,” Christof Ruehl, a senior analyst at Columbia University’s Center for Global Energy Policy, told Bloomberg.

“It reduces pressure on inflation, which is exactly what central banks need right now.”

Inflation in the United States cooled in August, also thanks to lower gasoline and energy prices, data from the Bureau of Labor Statistics showed this week. Last month, consumer prices rose at their slowest pace since 2021. The Consumer Price Index (CPI) rose 2.5% from a year earlier in August, a sharp drop from the 2.9% annual increase in July.

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The energy index fell 4.0 percent for the 12 months ended in August, the Bureau of Labor Statistics said.

Despite the fact that the inflation rate is falling, it still remains above the Fed’s target level of 2%.

The Fed is expected to make its first rate cut when the committee meets next week.

CME FedWatch, the tool that compiles the latest Fed rate move probabilities, shows that interest rate traders expect a cut on September 18. Most expect a 0.25 percentage point reduction, but 13% see a 0.5 percentage point reduction.

A weak US jobs report exacerbated recession fears on Friday and helped lower oil prices late last week.

But Treasury Secretary Janet Yellen said on Saturday that the US economy remains strong and may have managed a soft landing.

“I’m careful about the downside risk right now in terms of employment, but what I think we’re seeing and I hope we’ll continue to see is a good, solid economy,” Secretary Yellen said at the Texas Tribune Festival in Austin.

“It was really amazing to be able to reduce inflation as significantly as we did. This is what most people would call a soft landing,” she added.

Oil trading giants climbed on crude prices

If oil prices hold at current levels in the $70s or below, the soft landing could be closer than previously thought.

And major independent oil traders believe prices could remain at these levels or fall below $70 a barrel due to ample supply and weak demand from China.

At the APPEC event in Singapore earlier this week, oil trading giants Trafigura and Gunvor expressed bearish views on prices and demand.

Ben Luckock, Global Head of Oil at Trafigura, said on Monday morning that he expected Brent to fall into the $60s, although he cautioned that traders should not put all their eggs in the shorts basket.

The price of Brent “will probably get to $60 relatively soon,” Luckock said.

Gunvor co-founder and chairman Torbjorn Tornqvist told the conference that the fair value of Brent is now $70 a barrel because supply exceeds demand. The problem with oversupply is not OPEC+ policy, but the fact that the group has no control over non-OPEC+ supply growth, Tornqvist said.

If oil prices head towards $60 a barrel in 2025, “the likelihood of a soft landing would increase – that applies to both Europe and the US,” Tim Drayson, head of economics at Legal & General Investment and former UK Treasury. officially, Bloomberg said.

“Overall, it would be a net positive for the world to lower rates again and help central banks return to neutrality.”

By Tsvetana Paraskova for Oilprice.com

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