You will be hard pushed to find an economist or market-watcher who thinks that lower oil prices are not a good thing for the global economy. That is because they should lead to an increase in consumption driven by the unexpected extra money in everyone’s pocket.
Any first-year economics student will be familiar with the equation that output (gross domestic product) can be broken down into five components: consumption, investment, government spending, imports and exports. In a developed economy, consumption is often the biggest component in nominal terms. Lower oil prices can also lead to reduced investment by companies, particularly those in or closely related to the oil industry. This component of economic growth should therefore actually become smaller. However, in reality, consumption is such a large part of the equation, at nearly 70 per cent of GDP in the US and closer to two thirds in the UK. This means the consumption positives will outweigh the investment negatives.
The impact will not be the same in every economy. In fact, both the World Bank and the International Monetary Fund have recently reduced their 2015 forecasts for global growth. The IMF expects the global economy to expand by 3.5 per cent this year, down from the 3.8 per cent it forecast back in October. But much of that downgrade is based on the outlook for emerging economies, while growth expectations for the US were increased to 3.6 per cent and remained stable for the UK at a respectable 2.7 per cent.
The sharp decline in oil prices adds to the weaker growth outlook for those oil-exporting emerging economies and has given rise to fears over strengthening disinflationary forces. It has also raised concerns that central banks will further delay the inevitable tightening of monetary policy. The timing of that first rate rise in the UK and US has again been pushed back by markets, with many now expecting a move later in the year, or indeed not until 2016.
The unexpected decline in US retail sales last month reinforced market expectations of a rate rise. The US consumer should be one of the biggest beneficiaries of low oil. According to the US Energy Information Administration, the price of fuel has fallen from $3.64 (£2.39) to $1.99 (£1.31) in the space of seven months.
So where did the money go? The retail sales figure was distorted by the very thing that should have helped it rise, as fuel prices are included in this calculation. The other contributing factor was that statistical agencies may be slow in adjusting their calculations to account for the big shift to online sales. If you are anything like me, shopping consists of sitting on the couch with a laptop, and even then I still loathe it. Yet even with this one weak point in retail sales growth, consumer spending is well above trend compared to recent years, and as the chart shows, these figures are the most confident since the start of 2007.
In the UK, retail sales figures have been rising. The latest data, which is for November, saw retail sales rise by 6.4 per cent year-on-year. This was the largest increase since May 2009 and there is evidence we may see these stronger numbers continue. The unemployment rate continues to fall, albeit at a slower pace, and now stands at 5.8 per cent. More importantly, wages increased by 1.7 per cent according to the latest Office for National Statistics data, and with inflation running at 0.5 per cent, real wages are also moving in the right direction. With the continued rise in employment and some employers struggling to find employees with the right skills, wage pressures could build, reinforcing that boost to growth from the consumer.
Kerry Craig is global market strategist of JP Morgan Asset Management
