Bond Outlook [by bridport & cie, September 27th 2006]
| The drop in oil prices could well change significantly the development of the economy. In the short term it has already given a boost to consumer confidence and to stock markets. In the medium term, provided lower prices persist, it alleviates the “cost-push” inflationary pressure which has caused so much concern for us (and for such worthies as Paul Volker, former Fed Chairman) that even slowing the US economy would not suffice to prevent prices rising too fast. That is why some weeks back we suspected that the Fed would be obliged to raise rates still further after a few months. |
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| Cheaper energy prices change the whole scenario. They mean that the severity of the slowdown already being brought about by the interest rate hikes to date is lessened. To put it another way, the control of inflation should be returning to being a matter of matching demand to supply within the economy – conventional “demand pull”. |
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| Paradoxically, while cheaper oil diminishes the need to raise interest rates to combat inflation, it also removes the need for lower interest rates to save the economy from recession. |