Oil prices close in on $100: Will it reverse inflation progress?

Oil prices extended gains again on Thursday and hit a 2023 high supported by falling crude inventories and OPEC+ supply cuts adding to the woes of central banks trying to tame inflation.

It followed an update on inventories at a key storage hub in Cushing, Oklahoma. The EIA said stocks fell to 22 million barrels in the fourth week of September, close to the operational minimum.

At the time of writing on 28 September, US crude oil, or West Texas Intermediate (CL=F), rose 0.73% to trade at $94.36 (£77.54) a barrel, while Brent crude (BZ=F) climbed 0.75% to $97.27 a barrel, the highest level since November 2022.

The high oil prices support the case that crude could hit $100 a barrel by the end of the year, with Goldman Sachs also recently raising its price target to $100 for the next 12 months.

Craig Erlam, senior market analyst, OANDA, recently said: “At a time when central banks are starting to see the light at the end of the inflation tunnel, $100+ oil will be incredibly unwelcome and unhelpful. I'm not sure there's much economic sense in tipping the global economy into recession if OPEC+ persevered with these cuts, which makes me question how high the price will go and how sustainable it will be.”

Meanwhile, China's latest stimulus measures have also added to the bullish sentiment among traders.

Read more: LIVE: FTSE muted and Wall Street lower as UK set to see highest inflation rate in G7

So how might rising oil prices impact inflation and the wider markets?

Oil price rally impact on inflation

Russ Mould, investment director at AJ Bell, said policymakers will be watching the oil price very closely, as a sustained surge in crude could fuel inflation and at the same time depress corporate profit margins and squeeze consumers’ disposable income in a painful stagflationary pincer movement.

“Headline consumer price index measures of inflation have shown some welcome deceleration, or cooling, and lower oil and gas prices (plus government subsidy programmes or price caps) have helped to a good degree here. ‘Core’ inflation readings, which strip out more volatile (but vital!) elements such as energy, food, alcohol and tobacco, have shown less progress.

“Lower oil prices have therefore given central bankers a break, but if they go high and stay high then that could feed into higher headline inflation rates once more and leave policymakers with a problem, if they need to keep raising rates while the economy is slowing.”

Will rising oil reverse inflation progress?

Susannah Streeter, head of money and markets at Hargreaves Lansdown, said: “The worry is that higher fuel costs will make the transport of goods more expensive and lead to higher prices in the shops. Fuel is an essential and demand is usually less sensitive to rising prices and the risk is companies will keep passing on higher costs.

“However, another jump in prices at the pumps would mean consumers have less money to spend, could tighten belts further, pushing down demand elsewhere in the economy.”

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However, if higher oil prices linger for longer and inch up past the psychologically important $100 a barrel mark, it is set to add to expectations that any future cuts in interest rates will be pushed much further away on the horizon.

Meanwhile, Daniela Hathorn, senior market analyst at Capital.com, said the move above $100 would be based on geopolitics and could be unsustainable in the long run.

“The reality is that prices are already overextended and with forecasts that economies will continue to slow and in turn, demand for oil drop, it may be harder to find new buyers to fuel the rally further — even if Saudi Arabia and Russia hint at further supply cuts.

“Given how supply constrained energy markets are likely to become, especially amidst harsher weather approaching the end of the year, higher oil prices are both an upside risk to inflation and a downside risk to growth. Economies and markets that don’t export energy and suffer from energy insecurity could underperform in such an environment.”

Piero Cingari, independent macro analyst, said: “Rising oil prices undeniably exerts upward pressure on the overall economy's price levels. Notably, the energy component carries a weight of 7% in the US Consumer Price Index (CPI) and approximately 9% in the European CPI. It is evident that the greater the surge in energy prices and the weight of the energy item within the consumer basket, the more pronounced its impact on overall inflation become.”

Surging oil prices also result in increased costs for companies.

“However, the economic consequences of such price hikes vary widely among countries and hinge on whether they are net exporters or net importers of oil,” he Cingari added.

Consumer fuel price warning

The RAC also recently warned that drivers are “in for a hard time at the pumps” as a result of the high crude prices.

It comes as the average price of a litre of petrol has risen to 155.5p — up by 10p since the beginning of August, the most expensive level since December.

RAC spokesman, Simon Williams, said: “Diesel is set to jump in price from its current average of 159p a litre to over 170p."

He also said that prices on the forecourt are too high due to retailers taking bigger margins than normal.

“If they were playing fair with drivers, they would be reducing their prices rather than putting them up. However, if oil were to hit 100 US dollars, it should really only take the average petrol price up by another 2p. But if retailers remain intent on making more money per litre with increased margins then this could be closer to 160p,” Williams added.

OECD economic outlook

Meanwhile, the Organisation for Economic Development (OECD) said in its latest update of its forecasts for major economies that global gross domestic product (GDP) growth is on course to slow to 3.0% this year from 3.3% last year.

Global growth is also expected to slow to 2.7% in 2024 — down from its June estimate of 2.9%.

It forecast the US economy to grow 2.2% this year rather than the 1.6% it forecast in June as growth has proven more resilient than expected in the face of a series of rate hikes.

The Chinese economy is expected to slow from 5.1% this year to 4.6% next year as momentum from the end of COVID restrictions fades and the property market struggles.

The OECD predicted UK inflation is set to come in at 7.2% for 2023, increasing its previous forecast of 6.9% from June. This would be the highest rate across the G7 and third highest across the G20.

Read more: Euro area inflation lower than expected in August but still above ECB target

Britain will also one of the worst performing advanced economies, with growth in 2023 only outpacing Germany and Argentina, while next year only Argentina will be below the UK.

The group downgraded its expectations for UK growth next year by 0.2 percentage points, saying it now expects the economy to expand by just 0.8% in 2024.

The OECD further highlighted that central banks should keep interest rates high until clear signs inflationary pressures have subsided.

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