Published: September 29 2000 18:48GMT | Last Updated: September 29 2000 23:24GMT It worked! Despite the scepticism of analysts and the jeers of anti- capitalist protesters, the world's industrial leaders have shown a surprising ability to turn the tides in two important markets. Just before the Group of Seven meeting in Prague began, central banks, including the US Federal Reserve, intervened to stop the fall of the euro against the dollar. The effect was hardly dramatic. The euro rose 4 per cent from its low point of $0.847 the previous day. But a dangerous slide was halted. By the end of this week, the euro was still hanging on to that modest recovery, although it remained 25 per cent below its level in January 1999, when the new currency was launched. Even more important, the G7 leaders appear to have swung the oil price by a combination of bluster, persuasion and intervention. The US's decision to release 30m barrels from its strategic petroleum reserve helped to push oil prices back from a peak of $34 per barrel - a 15-year high excluding a brief peak in the Gulf war period. This week, after Saudi Arabia's Crown Prince Abdullah promised to increase production to meet increasing demand, prices fell back further, dipping comfortably below $30. Of course, a week is a short time in economics, but the apparent shifts in market sentiment have enabled policy-makers to breathe a collective sigh of relief. In the euro-zone, particularly, the possibility of $40 oil, combined with and ever-sinking currency, carried unwelcome implications for inflation, for interest rates and hence for the prospects of sustaining economic recovery. And that is not to mention the cries of protest from motorists and hauliers at the fuel pumps. Inflation control It was never likely that the US would agree to sustained intervention to push the euro back up against the market current. For one thing, a strong dollar helps it to control inflation and to finance a large current account deficit while growth remains robust. Still, it was obviously keen to curb extreme volatility in the euro/dollar exchange rate. Success in this endeavour must be welcomed, however temporary. At least it has provided the markets with a pause for reflection. The same is true in the oil market, where historically-low stock levels before the onset of winter were creating a fever of speculation. Because oil producers, including Saudi Arabia, have been pumping at close to their maximum capacity, there has been a possibility of physical shortages, particularly if the US winter is unusually cold. In that case, prices might spike to $40 or even $50 a barrel, before demand was curbed to match supply. The use of US, and possibly of European, reserves could lessen that risk. But in any case, few analysts believe such a price spike would last long. The tripling of oil prices from $10 per barrel in December 1998, has provided a strong signal to oil producers to increase production. There are still plenty of reserves underground, and the cost of extracting them is well below $30. According to some analysts the long-run, marginal cost of oil may be below $20 per barrel. Long-term rise Even so, as the recent rise has suggested, prices could stay well above that level for some time. This is especially likely if the world economy continues growing at 4 per cent a year, as the International Monetary Fund suggests. If oil prices were to remain high for a period, what would be the implications for investors and for governments? According to a paper from the Organisation for Economic Co-operation and Development this week they might be quite modest. It estimates that a sustained oil price of $33 - $10 more than it expected in May - would knock just under half a percentage point off OECD growth and add three quarters of a point to annual inflation. Investors who remember the sharp falls in corporate returns during the oil crises of the 1970s might brace themselves for another plunge. But according to Goldman Sachs, the investment bank, a temporary rise to $40 per barrel might cut corporate profit growth by as little as 1 percentage point from an expected 13 per cent during the next 12 months. But it says a cut of 5-6 percentage points is possible as a worst case. These projections reflect the fact that the corporate sector - and western economies as a whole - have become far less dependent on oil. As proportion of output, the OECD's oil and gas imports were 3� times higher in 1978 than they are now. A smooth reaction to higher oil prices depends crucially on whether the developed economies can control inflation. And that may require unpopular increases in interest rates, just when fuel prices are rising. Market intervention may have worked for a week, but in the longer term the authorities must be prepared for tougher measures. _______________________________________________ Crashlist resources: http://website.lineone.net/~resource_base To change your options or unsubscribe go to: http://lists.wwpublish.com/mailman/listinfo/crashlist
