OPEC deal allays some U.S. inflation concern

By Marjorie Olster

WASHINGTON (Reuters): Organization of Petroleum Exporting Countries (OPEC)'s agreement to boost oil output on Tuesday will probably allay some U.S. inflation concerns but consumer confidence may still suffer if Americans don't get some relief at the gas pumps.

U.S. officials said the accord by OPEC to immediately increase oil production by 1.45 million barrels per day will go a long way toward closing the gap between global demand and supply.

But analysts warned not to expect a precipitous drop in oil prices.

"We are not going to see much relief on energy," said Bill O'Grady, energy futures analyst at A.G. Edwards & Sons Inc. in St. Louis.

"It's not as much as the world needs. It's going to keep prices relatively high, comfortably above US$25 per barrel. But we are not going to retest $34."

Oil prices, which nearly tripled in the past year, had become a source of growing concern for U.S. economic and political leaders who saw a potential inflation threat. The price peaked at $34 a barrel earlier this month but was down to around $27 on Tuesday.

At the Federal Reserve -- the U.S. headquarters for the war on inflation -- officials have recently added oil to their list of possible sources of inflation.

But even before energy costs really came into focus, the U.S. central bank had been warning of inflation pressures from strong domestic spending and low unemployment which could push up wages and prices.

The Fed raised interest rates five times in the past nine months in an attempt to slow the galloping economy but with little effect so far. The OPEC deal was not likely to alter the expectation for even higher rates in the next few months.

It's not hard to see why rising oil prices make Americans uneasy. The memories of the last three major recessions are still vivid and all three were preceded by oil price shocks.

But the U.S. economy is much less vulnerable now to oil price swings, economists say.

Judging by the swarms of bulky sport utility vehicles crowding U.S. highways these days, it may not look like Americans are great energy conservationists.

But one of the reasons the Fed had been fairly sanguine about oil is because a host of measures to use energy more efficiently, implemented in the past two decades, have reduced dependence on oil.

Oil expenditures, as a percentage of economic output, have declined sharply in the past two decades.

Fed Chairman Alan Greenspan told U.S. lawmakers on Monday he would not expect oil prices in the mid-20s range to spark inflation. But he acknowledged that at some point, if prices continued to escalate, the economy would suffer.

"There is no doubt in my mind that energy,...if it gets sufficiently costly, could have some materially negative effects on the economy, inflation, growth, productivity and a variety of other related areas," Greenspan said.

Oil prices have not yet caused the kind of economic disruption that would dramatically alter the outlook for U.S. interest rates.

In the past several months, U.S. inflation has been creeping higher. But the central bank does not yet see evidence that higher oil prices are pushing up costs of a much broader range of goods and services.

"Currently we do not as yet, and I emphasize as yet, see any significant indication that crude oil price increases are in the process of embedding themselves in other areas of the economy and inflating the general price structure," Greenspan said.

For the Fed, rising oil prices at this stage of the expansion present a tricky problem. If prices rise modestly, they could act like a tax increase, slowing consumer spending.

That may be a welcome development for central bankers worried the economy is overheating. On the other hand, if oil prices do spill over to broader inflation, the Fed may feel pressure to raise rates more.

"It probably won't have a dramatic influence on the Fed," said O'Grady. "It could cool the economy and take some of the pressure off the Fed to tighten as aggressively as it might otherwise."

For Americans though, the true test of the OPEC accord will be at the gas pumps. If prices stay high through the summer driving season, it might start to erode consumer confidence and cut into consumer spending.

Gary Schlossberg, senior economist at Wells Capital Management in San Francisco, said the OPEC deal fell far short of the 3 million bpd rise the U.S. Energy Information Agency (EIA) said was needed to bring prices back in line with historic averages.

"This is going to be bullish for the oil markets but bearish for the U.S. economy," he said.