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Oil is well?

A strange development occurred in the oil market last week. With prices easing as fears of further disruption in the Gulf of Mexico receded and with a potentially major new find in that region, the price of Texas crude was actually lower than at the same time last year. This was the first time this had happened for more than two and a half years.

To be realistic, the situation was distorted by the fact that the price of oil experienced an upward spike a year ago following Hurricane Katrina. Even so, the price has steadied at levels that are encouraging, given that it was flirting with $80 a barrel just a few weeks ago. Clearly, the implications for inflation are benign but it is still too early to open the champagne. For a start, the situation in the Middle East could break down at any time. Iran’s intransigence and the lack of any real resolution to the conflicts in Lebanon and Palestine, lead one to draw the inevitable conclusion that geo-political concerns have not lessened. They have merely moved from centre stage for a while.

Should we really be so blas矡bout the likely course of inflation? Much of the justification for believing the rise in the cost of living is slowing in the US is the belief that the rapidly deteriorating housing market will dampen consumer ambitions. Certainly, economic data has been pointing to a slowing in activity in both the US and Japan but it is by no means a one-way street, with elements still providing some robust indicators.

Then there is China’s influence. There is little doubt that the explosion of manufacturing capability has held down prices of goods in the rest of the world and removed pricing power from Western companies. However, there are signs that prices of Chinese exports are rising, as the combination of a strengthening currency, higher raw material prices, rising domestic demand and better wages for the local workforce starts to create significant upward pressure. The big advantage that these new manufacturers had may be drawing to a close.

The situation remains difficult to call. The US bond market is anticipating a reversal of the tightening of monetary policy adopted by the Federal Reserve Bank, with rates falling during 2007 but we may not yet have seen the peak. If the American authorities do opt for a further increase in interest rates, it will do little for investor confidence.

Back home, last week’s decision by the Bank of England to leave rates unchanged was hardly a surprise. But rates have been rising elsewhere so it would be wise not to discount dearer money in the not too distant future.

For investors, the message is that the easy money has been made and the rest of the year will be difficult to call. A soft landing in America, with modest inflationary pressures, may yet be achieved. So much is going on elsewhere, though, that vigilance and a safety-first stance continue to look best advice.

Brian Tora is investment communications director at Gerrard Investment Management


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