The massive move higher of oil prices has seriously affected the dollar's rally and caused inflation to rocket, with worldwide ramifications, not least for banks, says Mark O'Sullivan
Back in March, with oil trading around $98, a cheeky trader put a trade through that triggered a level of $100, more to gain lifetime fame as the first man to hit $100 than for any financial gain, and the market looked on in disdain as the price dropped back to $96.
Today, oil trades at $130, with forecasts of $150, $175 and even $200. This huge move higher, which shows no sign of abating, has been bad news for the dollar and has caused its recent rally to slow as the world frets how this will affect the US consumer.
Inflation is now the key word, and every major central bank from the Bank of England to the Reserve Bank of Australia is restating the fact that inflation is their major remit and interest rates will remain on hold until it comes under control. And with the present levels of inflation, it looks like we are in for a rocky 2008.
Oil is priced in dollars, so any move higher puts the dollar under pressure, but conversely makes oil cheaper for Europeans as the exchange rate moves higher. At the moment, any chance of a US recovery in 2008 has been blown out of the water, and the euro/dollar exchange rate now looks like it could move to new highs of $1.63 to the euro. This would give the European Central Bank a double whammy of a strong currency at a time of rising inflation and potential global slowdown as the continued high price of commodities takes hold.
There is no doubt the world's central banks have got their work cut out: gone are the days of low inflation, low unemployment and steady growth. The Bank of England is struggling with its remit to control inflation at a time when the consumer and the housing market are experiencing a severe slowdown.
Despite this meaning that interest rates in the UK will stay higher for longer, the currency markets are looking beyond that at the actual state of the UK economy - and they do not like what they see. Consequently, sterling is still falling to all-time lows against a basket of international currencies.
One area to watch is the economies that have experienced huge growth, which may stall due to the price of oil. An example is India, where the value of the rupee has dropped by over 4% against the dollar in the past month alone, and further falls should not be ruled out.
- Mark O'Sullivan is director, dealing at Currencies Direct.
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