The impact of rising pump prices should feed into decisions on raising interest rates, says the Reserve Bank’s outgoing chief economist.
The price of a barrel of crude oil has jumped nearly $10 since Russia invaded Ukraine – but that’s not the number the members of New Zealand’s Monetary Policy Committee are looking at.
They had just locked in their decision to raise the official cash rate by 0.25 percentage points last week, when Russian shells began landing in Kyiv. Reserve Bank chief economist Yuong Ha was sitting on the committee for the last time, before he finishes his job next week – and he says the committee will now be looking at pump prices.
MBIE’s weekly tracking shows diesel and petrol rising nearly 3c the day after Russia invaded; figures from Gaspy show prices rising since then. Diesel has topped $2.30/litre at some Auckland service stations, and regular 91 petrol is nudging $3/litre today.
Increased pump prices will show up as higher near-term consumers price index inflation, says Ha. “Ultimately that’s where the rubber hits the road for us.”
He says it’s too soon to tell whether fuel price rises will be sustained – indeed, the markets had already priced in worsening news from Ukraine.
“The volatility is going to be more heightened, because not only have you got the impact, you’ve got the rolling sanctions that might come, and the reactions to those sanctions.”
Some of the effects will balance out. New Zealand will earn more from its export commodities but households will pay the price at the pump.
Ha predicts the higher fuel prices will cause an increase in short-term inflation but, in the medium term, they may have a dampening effect on economic activity and growth, because of the hit to disposable incomes.
“If you’re spending more on petrol, you’re going to be spending less on something else – so that’s the equation we have to look at. How do households respond to essentially an income shock? It’s like when we raise interest rates, that’s going to be an income shock for people with mortgages. How do they respond with their remaining disposable income?”
These oil prices are by no means the highest the world has seen. Crude oil is tracking towards US$100 a barrel, but that’s nowhere near as bad as the global financial crisis, when it sat at more than US$140 a barrel in June 2008.
“When prices go high, supply responds,” Ha says. “And 2008 was kind of the catalyst for the fracking industry. It basically catalysed a lot of new investment that brought supply onstream, and oil prices eventually returned to something that was more akin to the marginal cost of production.
“That fracking pipeline is there, to some degree, so that’s providing some anchor to where prices should gravitate towards, ultimately. But fear and uncertainty risk premiums will be the thing that dominates pricing for now."
Before the Covid pandemic, hundreds of private US companies operated thousands of small fracking wells from Texas to North Dakota, embodying the “pump all the oil you have” strategy. As The Atlantic reports this week, these companies were flooding the market with cheap oil by unlocking hidden reserves locked in shale deep underground, crowding out the Opec countries from their traditional cartel role. But there were so many of these shale companies that most were losing money.
Then the pandemic hit. People stopped driving and flying. Oil demand crashed worldwide – and the fracking companies collapsed.
Now there is political pressure in the US to encourage more oil production from the fracking industry – or for Joe Biden’s administration to take a more direct role in fossil-fuel production outright to drive down prices.
“Six months ago, we would have said inflation has blipped up and it would blip down," Yuong Ha adds. “We’re of the view now that it’s blipped up and price levels will probably stay up for a bit longer ... We have to think about how households respond to these elevated oil and energy prices.
“Inflation basically erodes people’s purchasing power. That’s why we ultimately are trying to keep things low and stable – so people don't have to worry about whether a dollar today will buy the equivalent of a dollar’s worth of goods and services tomorrow.
“I think for most households, inflation has supplanted housing as the number one concern for New Zealanders. People understand that inflation right now is very different to where it was. And that’s probably the biggest challenge we now are facing, compared with 12 months ago when we were worrying about the size of the economy and the state of employment.”
