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Historically, there is often a sequential relationship between rising oil prices and high inflation, but is there a causal relationship between them?

Inflation devalues the currency, leading to higher prices for consumer goods and services, while the rising cost of living in turn affects individual optional consumer spending and economic growth. Recently, oil prices have risen rapidly, and the market is once again worried about the U.S. inflation rate picking up.

Historical data showed a correlation between rising oil prices and inflation. But there is evidence that the link between oil prices and inflation began to break decades ago. Bob Iaccino, co-founder of Path Trading Partners, said the relationship weakened after oil prices soared in the 1970s.

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How does the oil price affect the macro and micro economy?

Higher oil prices lead to higher prices for a wide range of goods and services, which in turn could lead to a decline in optional consumer spending, eventually leading to a slowdown in economic growth or even a recession.

There has been a sharp rise in oil prices before the past three recessions. Paul Hickey, co-founder of Bespoke Investment Group, said one possible trigger for the end of the bull market was a spike in oil prices. Nicholas Colas, co-founder of DataTrek Research, agreed and said the auto industry economy in the 1990s showed that a recession was expected if oil prices rose 100% within a year.

However, many economists disagree, saying the recession was caused not by rising oil prices, but by the Fed's efforts to curb demand by raising interest rates.

How does rising inflation affect oil producers?

Dmitry Marinchenko, a senior director at Fitch, explained that higher oil prices may bring more profits to oil producers, but at the same time it will raise their indirect costs. Speaking about the inflation environment in 2022, he said rising industry activity and widespread inflation could be painful for many producers. Many companies have slashed costs over the past few years, and now that trend may be reversing.

What is the relationship between oil pirces and Consumer Price Index (CPI)?

Historically, the consumer price index (CPI) and oil prices have moved highly in line, and this cause-and-effect relationship was best demonstrated in 1973. That year, the Saudi-led Organization of Petroleum Exporting Countries (OPEC) imposed an oil embargo on the United States, combined with the 1979 Iranian revolution, and oil prices soared, resulting in the United States CPI more than doubled by the end of 1980. By comparison, it took 24 years (1947-1971) for CPI to double.

Since then, however, the relationship between oil prices and CPI has weakened. In six months in 1991, during the first Gulf War, oil prices rose from $14 to $30 a barrel, but the CPI barely responded. In addition, oil prices rose from $16 to $50 between 1999 and 2005, but the impact on CPI was also minimal. More importantly, the recent oil price spikes have had little impact on economic growth, unemployment, or inflation.

What is behind this decoupling? Some say that energy efficiency has reduced energy consumption per dollar in many industries. Others argue that monetary policymakers have changed the way they control inflation since the 1990s, softening the impact of higher oil prices. In addition, economists, including those at the St. Louis Fed, have noted that the U.S. CPI basket is increasingly weighted toward services rather than oil-linked goods.

What is the relationship between oil prices and Producer Price Index (PPI)?

However, the relationship between oil and inflation has weakened but not completely disappeared. Compared to the CPI, the St. Louis Fed said oil prices are now more closely related to the producer Price index (PPI).

Between 1970 and 2017, the correlation between oil prices and PPI was positive at 0.71, compared to 0.27 with CPI. Path Trading Partners' Iaccino said crude oil doesn't seem to be much of a hedge against inflation, but it is useful for predicting inflation trends.

Higher interest rates, higher oil prices?

Iaccino noted that during the past six rate hike cycles, WTI crude oil futures prices rose an average of 16.06% six months after the rate hike. Is the rise in crude oil prices after a rate hike causation or mere coincidence?

Although oil is a driver of inflation, changes in interest rates have little impact on oil prices in the short to medium term. In contrast, the price of crude oil is influenced by a number of factors, including geopolitical events that lead to sudden increases in supply or demand. Take the recent surge in oil prices, compared to the Federal Reserve's interest rate hike, the decline in U.S. crude oil inventories and the supply pressure caused by OPEC production cuts have a greater impact on oil prices. $WTI Crude Oil - main 2311(CLmain)$ $Micro WTI Crude Oil - main 2311(MCLmain)$ $Brent Last Day Financial - main 2311(BZmain)$