Inflationary Fear of Higher Oil Prices Overdone?

The markets are paying close attention to oil prices now that they've broken above $70/bbl.   Some analysts expect the price to climb as high as $80 in coming months.  The fear that this will spur higher inflation is probably overdone, however.  At some point, the Treasury market should realize it has overreacted.

The run-up in oil prices, like the imposition of tariffs, is a relative price change.  To be sure,  it will show up in a wide range of price increases as this cost gets passed through to the consumer.  But, even these pass-throughs will end eventually.  If natural gas prices get pulled up in the process, there actually could be an offset in the Core CPI -- they could hold down the important Owners' Equivalent Rent, since they are subtracted out of rent in the calculation of OER.  Also, retailers could cut other prices (taking a hit on margins) in response to a softening in consumer spending on non-oil goods and services.

The rise in oil prices would be inflationary only if it leads to faster wage inflation, which would be the case if labor is successful in regaining its lost purchasing power.  The relationship between oil prices and wage inflation is tenuous, however, now that cost of living adjustments in labor contracts are rare.

The increase in oil prices is a net negative for the real economy.  On the negative side, consumption will be hurt.  With the US consuming 7.2 Bn barrels of petroleum products a year and oil prices up over $13/bbl this year, the increase is equivalent to a tax increase of about $100 Bn (about 0.5% of GDP).  On the positive side, slightly less than half of this amount is "collected" by domestic oil producers.  Their increased revenue should lead to increases in oil production, investment in oil wells, and dividends.  On balance, the run-up in oil prices could subtract 0.2-0.3% pt from GDP Growth.