Oil price to give growth fuel-injected boost

Alister Bull and Ashley Seager, Reuters, Frankfurt/London

Cheaper oil could provide just the tonic the world's battered economy needs as it confronts a looming recession expected to hit next year.

Oil prices plunged to a two-year low of US$16.80 per barrel on Thursday and has steadily defied fears that it would soar to $50/barrel or more after the September attack on U.S. cities .

The fall was after OPEC delayed implementation of a 1.5 million barrel per day cut on output to apply pressure on rival producers. This is bad news for oil exporters, but it is very good news for the rest of the world.

Cheaper oil has the virtue of boosting demand without igniting inflation, which means that central banks can keep on cutting interest rates as growth slows.

"Lower oil prices puts money into the pockets of people who buy things produced with oil and provides a potentially significant demand boost," said Professor Paul Seabright at Toulouse University in south western France.

That is, if households and businesses spend the extra cash that a fall in oil prices delivers. So oil will only help if confidence returns, which was already sagging and then went into shock over Sept.11 attacks on the United States.

Horror at the destruction of the World Trade Center and the unraveling of a huge technology investment bubble has crimped consumer and business demand and threatens the world with its first serious slowdown in a decade, the IMF warned on Thursday.

But central banks on both sides of the Atlantic have slashed borrowing costs to restore confidence.

If a record leap in October U.S. retail sales is any guide the strategy is working, and cheaper oil will give their efforts a crucial boost.

Economists at the OECD estimated in September that the positive supply shock of a 50 percent fall in the price of oil would add 0.3 percent to U.S. economic growth in the first year and lop half a percentage point off its rate of inflation.

"The maximum impact on prices is seen during the first six to 12 months," said economist Christpohe Andre at the Paris- based Organization for Economic Cooperation and Development.

Others argue the impact could be more substantial, including Professor Andrew Oswald, an oil expert at Warwick University, who two years ago predicted a world recession when oil prices surged above $35 per barrel. It currently stands at $18/barrel.

"Oil has now halved from its peak. If it stays around here, that would be enough to add around two percent to world employment. This could be an enormous benefit to the world economy," he said.

"It takes about 18 months for a big movement in oil prices to impact the real economy so I still think we are going into a recession in the coming months, but I think it will be short- lived," Oswald said.

Economists at CSFB estimate that a $10 fall in the price of oil per barrel would add 0.5 percentage points to world growth, pushing it back above this threshold.

True, oil dependence has changed a lot since the crisis of 1973 when OPEC held the world to ransom over prices and set in motion one of the longest recessions for fifty years.