Oil Spilling Over Into Central Bank Policy as Fed Enters Fray

Norway’s central bank stunned investors last week by cutting its main interest rate to head off a “severe downturn” due to plunging oil prices. Ninety minutes later, Russia’s central bank raised its benchmark to bolster a currency weakened by crude’s decline.

The split among two of the largest oil exporters shows how the slump in the price of crude to its lowest in five years will make 2015 a year of divergence for global central banks and increased volatility in financial markets.

The U.S. Federal Reserve enters the fray this week. Some economists expect it to drop the commitment to hold rates near zero for a “considerable time.” Hiring is accelerating and officials including Vice Chairman Stanley Fischer have emphasized the boost to consumer demand from oil’s decline.

Cheaper oil “lends support to our expectation of monetary-policy divergence next year, making Fed tightening in the first half more likely, while pushing other central bankers to be relatively more dovish,” Credit Suisse Group AG economists led by Neville Hill and James Sweeney said in a Dec. 12 report to clients.

They analyzed 18 economies to gauge the effect of oil’s drop -- on prices and growth and fiscal and monetary policies.

Stimulus Impact

Because it threatens to drag down inflation, the fall in crude supports the case for more stimulus in the euro area, Japan, South Korea, India and Turkey, they reckon. It could slow tightening in South Africa, the U.K., Canada and Malaysia.

On the flip side, by acting like a tax cut in the U.S., where consumer spending accounts for two-thirds of the economy, crude’s drop is a seen as a reason for a turn in monetary policy; they see the first interest-rate rise in eight years coming in 2015 regardless of recent doubts on that score from Nobel laureate Paul Krugman.

“The fall in oil prices increases our conviction that the Fed will start tightening in June,” the Credit Suisse team said.

That fits with the analysis of Deutsche Bank AG economists who noted last week that past Fed studies found only a tiny impact from oil on underlying inflation, yet labor-market data suggest a 40 percent fall adds 1 million jobs.

Likewise, UBS Group AG economists say this week’s Fed meeting will start a “multimonth process of preparing” investors for a turn in rates as early as June. Oil’s drop has already been enough to boost UBS’s U.S. growth forecast for next year to 3.1 percent from 2.9 percent.

“The current large gap between market expectations and the Federal Open Market Committee’s Fed fund rate forecasts for both 2015 and 2016 raises the risk of an outsized market move,” said UBS economist Drew Matus. “It seems likely that the market will get its first dose of medicine this coming Wednesday as the FOMC begins a sustained, gradual effort to shift market expectations closer to the Fed’s own forecasts.”

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