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How oil seeps into inflation

| Posted by: Paul Donovan | Tags: Paul Donovan Weekly

  • The price of Brent crude oil moved from over USD 56 per barrel to around USD 50 in recent weeks. What does this mean for consumer price inflation?
  • Crude oil has no direct role in calculating consumer prices. Pouring a barrel of crude oil into the engine of your car would have disastrous consequences. Consumers buy refined oil, not crude. The difference between crude and refined oil prices is basically labor costs. In economies with tight labor markets, rising labor costs can blunt the effects of falling crude oil prices for the consumer.
  • Crude oil is behind 3% to 5% of the consumer price inflation basket. Oil prices leak into lots of other prices to get that contribution. Obviously, gasoline is influenced by crude oil, but airfares also have a large oil component. Food prices will include oil used in transport, in food processing, and in manufacturing fertilizer. Prices like fertilizer with "embedded" oil costs do not react immediately to changes in the price of crude oil – it takes time for oil prices to seep through the economy.
  • Investors must consider crude oil prices, labor costs, and delayed embedded oil price reactions when assessing the impact of oil on consumer prices.