# Explainer-Oil price surge changes ECB narrative only at the margins
Author:  Pal Sinha, Barnali 
Author URL: https://financedigest.com/author/pal-sinha-barnali
Published: 2023-04-03
Category: NEWS
Category URL: https://financedigest.com/category/news
Meta Title: How Will Oil Price Surge Impact ECB Policy?
Meta Description: Discover the effects of recent oil production cuts on European Central Bank policy and inflation, and how it may influence future rate decisions.
URL: https://financedigest.com/explainer-oil-price-surge-changes-ecb-narrative-only-at-the-marginshtml

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FRANKFURT (Reuters) – An oil production target cut announced by some of the world’s top exporters is bad news for the European Central Bank as it tries to bring down inflation but will not fundamentally alter the policy outlook, at least for now.

The following examines how higher crude prices – which jumped around 5.5% on Monday following the OPEC+ decision – could impact ECB policy.

IS AN OIL PRICE SURGE INFLATIONARY?

A spike in energy [prices was the main driver of inflation over the past year, but energy is now a drag on prices as oil](https://www.financedigest.com/oil-prices-rebound-after-opec-upgrades-china-demand-outlook.html "Oil prices rebound after OPEC upgrades China demand outlook") is trading well below its levels of a year ago.

Brent crude is down by one-fifth from this [time last year](https://www.financedigest.com/30-years-of-excel-lence-time-to-move-on.html "30 YEARS OF EXCEL-LENCE: TIME TO MOVE ON?") and its surge on Monday leaves it in line with its levels of a month ago.

At these levels, energy prices remain a disinflation force, as the price is significantly lower than it was a year ago,” Paul Donovan at UBS Global [Wealth Management](https://www.financedigest.com/wealth-management-consultant.html "Wealth management consultant") said.

Longer-term [inflation expectations](https://www.financedigest.com/ecb-survey-shows-rising-inflation-expectations-despite-energy-price-falls.html "ECB survey shows rising inflation expectations despite energy price falls") actually fell on Monday, while a short term market-based indicator barely edged up, suggesting that investors do not see a significant inflationary impact.

Part of the issue is that high energy prices [slow growth](https://www.financedigest.com/uk-recruiters-slow-pace-of-pay-growth-in-march-rec-survey-shows.html "UK recruiters slow pace of pay growth in March, REC survey shows") further out and thus become deflationary because they reduce households’ and businesses’ purchasing power.

IS THERE NO IMPACT ON POLICY?

There could be, mostly in the unwinding by investors of some recent bets that central banks will stop hiking rates earlier than they had planned, spooked by the recent banking turmoil and taking comfort in the quick [fall in headline inflation](https://www.financedigest.com/boes-mann-falling-headline-inflation-high-core-make-policy-difficult.html "BoE’s Mann: Falling headline inflation, high core, make policy difficult").

Higher energy prices could reinforce inflation fears and – provided there is no further financial market [turbulence – prompt policymakers to emphasize the need](https://www.financedigest.com/analysis-global-climate-coalitions-need-safer-harbour-from-antitrust-turbulence.html "Analysis-Global climate coalitions need safer harbour from antitrust turbulence") to keep raising borrowing costs.

Investors now see only another 60 basis points of rate [hikes from the ECB](https://www.financedigest.com/big-ecb-hike-adds-fuel-to-the-banking-sector-fire.html "Big ECB hike adds fuel to the banking sector fire"), a downgrade compared to about 110 basis points expected just a few weeks ago. These [bets on the so-called terminal rate](https://www.financedigest.com/investors-trim-bets-for-peak-bank-of-england-rate.html "Investors trim bets for peak Bank of England rate") rose only a few basis points on Monday.

The case for more ECB [rate hikes](https://www.financedigest.com/ecbs-villeroy-rate-hike-signals-strong-confidence-in-european-banks.html "ECB’s Villeroy: rate hike signals strong confidence in European banks") is still intact,” UniCredit said in a note. Forwards are pricing in just an 80% probability of a 25 bps [rate hike](https://www.financedigest.com/uk-economys-unexpected-bounce-spurs-more-boe-rate-hike-talk.html "UK economy’s unexpected bounce spurs more BoE rate hike talk") (in May), which is still too low, in our view.

HOW QUICKLY WILL THE ECB REACT?

Not quickly at all. The [central bank](https://www.financedigest.com/governments-and-central-banks-risk-inflation-bank-of-england-has-done-its-bit-now-the-politicians-turn.html "Governments and central banks risk inflation, Bank of England has done its bit, now the politicians’ turn") acts on longer-term trends and looks through this sort of market volatility. For policy, longer-term pricing matters more, and oil futures further out rose by less than half the spot [price increase](https://www.financedigest.com/syngenta-4q-profit-falls-as-raw-material-prices-increase.html "Syngenta 4Q profit falls as raw material prices increase").

While [consumers will see pump prices](https://www.financedigest.com/france-leans-on-retailers-to-help-consumers-cope-with-food-prices.html "France leans on retailers to help consumers cope with food prices") rise within days, the impact on inflation is more subtle. A 10% durable rise in [oil prices](https://www.financedigest.com/oil-prices-steady-as-news-of-saudi-russia-meeting-calms-investors.html "Oil prices steady as news of Saudi, Russia meeting calms investors") increases overall inflation by just 0.1%.

A lot of factors influence our world and they should not be evaluated in isolation to gauge their impact on [inflation and ECB](https://www.financedigest.com/euro-zone-consumers-more-optimistic-on-inflation-ecb-survey-shows.html "Euro zone consumers more optimistic on inflation, ECB survey shows") decisions. We [need to take all of them into account,”](https://www.financedigest.com/5-countries-you-need-to-have-an-offshore-account-in.html "5 Countries You Need To Have An Offshore Account In") ECB policymaker Gediminas Šimkus said on Monday.

For [rate decisions](https://www.financedigest.com/wage-data-dents-dollar-recovery-before-fed-rate-decision.html "Wage data dents dollar recovery before Fed rate decision"), the broader trends are much more important than a single factor.

Another [key issue is that the ECB](https://www.financedigest.com/morgan-stanley-others-now-forecast-4-peak-for-key-ecb-rate.html "Morgan Stanley, others now forecast 4% peak for key ECB rate") is now increasingly focused on underlying inflation, which filters out volatile energy and food costs.

This measure is still accelerating, so policymakers’ main worry is not oil, but that last [year’s episode of sky-high inflation](https://www.financedigest.com/spains-inflation-to-be-lower-this-year-than-in-2022-minister.html "Spain’s inflation to be lower this year than in 2022 -minister") has seeped into the broader economy, exerting upward pressures on wages and services.

HOW WILL OTHERS REACT?

The U.S. Federal Reserve is the [key player](https://www.financedigest.com/fish-feed-market-detailed-survey-on-key-trends-leading-players-revolutionary-opportunities-2030.html "Fish Feed Market – DETAILED SURVEY ON KEY TRENDS, LEADING PLAYERS & REVOLUTIONARY OPPORTUNITIES 2030"). If high energy prices spook the Fed, rate-cut bets will unwind and [push up the dollar](https://www.financedigest.com/powells-warning-on-higher-u-s-rates-pushes-dollar-to-3-mth-high.html "Powell’s warning on higher U.S. rates pushes dollar to 3-mth high"). This then adds to the case for other central banks to hike, to counter the risk that inflation will be imported into their economies via commodities and other goods and services that are priced in [dollars on world](https://www.financedigest.com/world-stocks-cling-to-upbeat-mood-dollar-stalls.html "World stocks cling to upbeat mood, dollar stalls") markets.

(Reporting by Balazs Koranyi; Editing by Catherine Evans)


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