Recently new report was released by BofA Merrill Lynch Global Research, titled, “BofA ML Economics: Global Economics – An oil shock to the global economic forecast”, authored by the Global Economics Team.
As the data flow has improved, BofA Merrill Lynch Global Research has been leaning toward bumping up it’s global growth call. Unfortunately, the oil price surge more than cancels out that upgrade. The commodity team has significantly increased its baseline forecast. As a result, the analysts have trimmed 0.1ppt of global GDP in both full-year 2011 and 2012 to 4.3% and 4.8%, respectively.
At the same time, the research team boosted global CPI inflation by 0.2ppt in 2011 to 3.9%, leaving 2012 unchanged at 3.4%. With offsetting growth and inflation implications, the forecast revision has had only a minor impact on the G-3 central bank calls. BofA Merrill Lynch has already pencilled in early rate hikes in the UK and the Eurozone. The team has made some upward revisions to it’s rates calls in the emerging economies, especially in LatAm and EEMEA, the latter due both to the oil shock as well as to the expectation of earlier hikes by the ECB.
Even with this forecast revision, the risks around growth are heavily skewed to the downside. If the production shutdown spreads outside of Libya, BofA Merrill Lynch Global Research will be revisiting it’s forecast again and if oil prices go above their historic peak of about $150/bbl on a sustained basis, a global recession becomes a real risk; at $200/bbl a recession seems almost certain.
Shock absorber
In the 1970s, oil shocks had large impacts on both growth and inflation. This reflected stronger union power, wage indexation and lack of central bank credibility. However, a wide range of research suggests oil shocks have less powerful impacts today. For example, a 2007 study by Blanchard and Gali found that an unexpected 10% increase in oil prices reduced US GDP growth four quarters later by nearly 0.5 pp in the 1970s and early 1980s, but by less than 0.2 pp since 1984. Similarly, a 10% shock raised US CPI inflation by about 0.5 pp in the pre-1984 period, but only by 0.25 pp on average since 1984.
As a rough rule of thumb, a $10/bbl increase in oil prices cuts GDP growth in consuming nations by 0.1 to 0.5 pp, with more recent models at the lower end of that range. BofA Merrill Lynch Global Research believes the latest shock will have a bit smaller than normal “bang for the buck” for the US and many emerging markets economies, but a “normal” impact on Europe. The US benefits from an abundance of natural gas and from refining capacity for sour crude. This helps explain the big gap between WTI and Brent prices (Chart 1). By contrast, Europe is more exposed than normal because it primarily consumes the “sweet crude” produced by Libya and regional refineries are not designed to handle the “sour” backup supply.
Emerging markets are better able to handle a moderate price increase due to their strong budget positions, which will allow them to subsidize or offset the impact of higher oil prices. BofA Merrill Lynch Global Research econometric estimates, and the new forecasts show a very marginal negative impact for 2011 GDP growth in the emerging economies.
More detailed forecasts will be available in BofA Merrill Lynch Global Research weekly and daily publications.
