Good morning. This is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's seven o'clock in the morning London time on Tuesday the 5th of May.
Markets have had a fairly muted response to the exchange of fire between Iran and the United States. US President Trump's positive assertions over the course of the weekend had been largely ignored by investors on Monday. Credibility was given instead to the Iranian threats.
So the idea of ongoing problems in the Strait of Hormuz was already more or less in the price. We're still not close to the level of oil price required to slow global demand by 7% or so, which is what is estimated to be required once oil reserves have been exhausted. So within that pessimism on the current situation, there is still a residual optimistic bias built into asset pricing.
Various politicians around the world have been proposing attempts to mitigate the damage to consumers with reduced energy taxes or price controls. That of course will not help. Supply is down and demand needs to come down to match that eventually.
Artificially suppressing prices does not reduce demand, it will just create pressures for even higher crude oil prices. Higher oil prices need not create concerns over earnings growth in the near term because there is an expectation of costs being passed through to the end consumer. We saw exactly this with US tariffs, a different sort of supply shock, but one that is helpful as a guide to pricing power and the likely responses of companies.
Margins are likely to be maintained as long as consumers are able to scale back savings rates in order to pay for the higher prices. This is not profit-led inflation. Margins shouldn't be expanding in this situation.
It's simply relative pricing power. When consumers in developed economies began the year with pretty good household finances and fairly large amounts of saving. The fact that rising inflation might be met out of consumers' savings helps to account for some of the European Central Bank commentary yesterday with a suggestion that inflation might be more affected by the oil price move than the growth rate will be.
The range of comments was fairly predictable. Nagel offered a Pavlovian, we should hike response while Villaroy, equally predictably, urged caution in the absence of a critical mass of data. This is the key point.
If second round inflation effects are to determine whether interest rate increases are required, it is still far too soon for evidence of profit-led inflation or, less likely, a wage price spiral to emerge. In the US, Federal Reserve President Williams said that rates will have to go down eventually and that higher inflation now was simply postponing that. Those remarks suggest a belief that second round effects will be contained.
The data calendar is pretty light today leaving markets free to react to any further events in the Gulf. There are import and export numbers for the US from March. These will be affected by higher oil prices, both on the import and on the export values.
The impact is still likely to be fairly muted in the March data, however. These numbers are a reminder that a better trade balance can and will improve GDP without improving the living standards of most people in a country. That's all for today.
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