Sun, Mar 17, 2002 - Page 11 News List

War with Iraq may cause oil to rise, markets to fall

REUTERS , LONDON

A US effort to oust Iraqi leader Saddam Hussein would roil global financial markets, with a potential spike in the price of oil undermining stocks and bonds even as an economic recovery takes hold.

But even an invasion may not do lasting damage to financial markets if supplies of oil are not badly interrupted because of conflict or backlash from other producing nations.

US President George W. Bush has stepped up his rhetoric against Iraq, which he has branded part of an "axis of evil," while his Vice President Dick Cheney is touring the Middle East to try to build support for possible action against Baghdad.

The impact on financial markets is already being seen, with two and three dollars added to the price of oil as a "war premium" since talk began a couple of weeks ago, analysts said.

The Swiss franc, which usually benefits from safe haven flows in times of uncertainty, hit two-month highs against the dollar on Friday, with the move partly attributed by traders to fears over Middle East conflict.

Analysts said that rising tensions would likely result in at least a short-term rise in the price of oil from its current US$24.50 per barrel, hitting bonds on rising inflation concerns and dampening the profit outlook for many companies.

"Iraq is one of the reasons why markets haven't been running better on the good economic news out of the US," said Simon Rubinsohn, chief economist at Gerrard Ltd in London.

"Bond yields have climbed in recent days, which you wouldn't have expected given the fall in stocks, and that is largely the result of the rise in oil prices."

An economic recovery is underway in the US, brightening the outlook for growth worldwide. But investors have been concerned about the resilience of consumers, who would have less disposable income as energy prices rose and face higher charges on debt if inflation pushes interest rates up.

"If you saw oil going to US$30 then all markets would start to react quickly," said Malcolm Melville, currency strategist at Morley Fund Management in London.

"The US must be aware that an oil price shock is good for no one, especially not them as they come out of recession."

Beyond the price of oil, a change of government in Iraq would involve great risk however it is achieved, investors said, and stock and bond markets would move to discount this risk until the outcome became clear.

Energy analysts, though conceding that fears over action against Iraq had driven the price of oil higher, were relatively relaxed about the medium-term effect.

Brent crude has risen from under US$20 per barrel on Feb. 26 to US$24.56 currently.

OPEC, of which Iraq is a member, agreed on Friday to keep a cap on oil output for three months, leaving consumer nations to fret that crude might race out of control before the cartel eases open the taps.

While Iraq accounts for about five percent of global oil supply, there is more than enough spare capacity to make that up if other nations are willing to fill the gap, analysts said.

"My guess is that [other Middle Eastern nations] would not impose an embargo at any time, they would voice displeasure," Lawrence Eagles, an oil market analyst at GNI Research.

However, Eagles said that other Middle Eastern nations would not want to appear to be supporting an invasion and were unlikely to respond to a spike in the oil price by increasing supply. He said that the US was likely to release oil from its strategic reserves in the event of interruptions of supply at the time of any attack.

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