Economy rides the storm

Jan 4 2008 by Iain Laing, The Journal

A NEAR-YEAR-LONG surge in the cost of oil has now seen crude hit $100 a barrel for the first time, but the economic impact has been less catastrophic than many would have feared.

Economists in the past would shiver at the prospect of oil hitting the psychological $100-a-barrel level and the possible havoc it could wreak.

The knock-on effect on manufacturers, economic activity and the cost of living for consumers would have been enough to bring the economy to its knees, many assumed.

But the UK has suffered a relentless rise in the cost of the black stuff over the past 12 months, and still the economy has continued rising. Inflation, too, has receded since an early 2007 spike to settle back around the Government’s 2% target.

The headlines suggest consumers have been harder hit, with the price of petrol at the pumps racing past £1 a litre and the cost of food also leaping up as producers pass on additional fuel expenses.

Yet the increase in the cost of living in the UK, at 2.1% in November, is rising at a slower pace than both the eurozone, at 3.1%, and America, now above 4%.

Philip Shaw, chief economist at Investec, recalls a conversation seven years ago with a fellow economist who predicted that if oil prices rose past the then-giddy heights of $30 a barrel, it would trigger a full-blown recession in the UK. Oil has now been trading at more than three times that level for a number of months, but has yet to cause a domestic economic crisis.

This is partly because rather than oil prices slowing the economy, it has been the sure strength of economies globally that has pushed up the cost of crude, said Mr Shaw.

“It would be particularly churlish to say that higher oil prices could tip the economy into a recession, given that it’s the sheer strength of the global economy that has been responsible for the hike in crude costs,” he said.

He added that economies have been able to cope with the recent rocketing oil prices as industries worldwide are now less dependent on oil. Price spikes in the 1970s and 1980s were far more disastrous, coming at a time when industry was a heavy oil user.

Economies have since largely switched from manufacturing to service-based industries, such as banking and technology, which has enabled many to weather the price hikes.

And while manufacturers have increased prices in some areas, they have also been absorbing many of the fuel cost rises, according to the sector’s trade body, the EEF.

Greater efficiency and cost control among many manufacturing businesses has given them room to cushion the blow.

Not every sector has fared so well, with oil-dependent firms such as airlines and food manufacturers hit deep in the pocket. British Airways announced at the end of last year that it expected to spend a record £2bn on fuel in 2007 and has since upped its fuel charges on tickets as a result.

Food firms have also been passing on costs in the form of higher prices.

These factors have put some upward pressure on the Consumer Prices Index (CPI) – the UK’s official measure of inflation – as has the rising price on petrol forecourts. But since March last year, when CPI hit its highest level in at least a decade, inflation has been kept largely under control.