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Climbing oil prices could delay hike in interest rates

Protesters carry portraits of Palestinian leader Yasser Arafat and Iraqi President Saddam Hussein during a street demonstration in the southern port city of Sidon. Some 3,000 people demonstrated to show their support for the Palestinians in the West Bank and to Saddam's decision to withhold oil exports. PHOTO: AP

Rising oil prices may pose a larger threat to the US economic recovery than to inflation, leading Federal Reserve policy makers to put off raising interest rates until after the middle of the year, economists said.

Consumers who spend more for fuel will have less to spend on other goods and services, impeding the recovery. Higher energy costs will also cut into business profits. Crude oil prices have risen as much as 40 percent this year as Middle East violence has escalated and expectations have risen that consumption will rise.

"That means the Fed stays on hold longer than it otherwise would," said Maury Harris, chief economist with UBS Warburg LLC in New York. He sees the Fed waiting until November, after elections for US congressional seats.

The economy is rebounding from a recession that began in March 2001.

With the Fed's benchmark interest rate at a 40-year low, many economists and investors have been expecting for rate increases to begin in May or June to prevent the economy from overheating.

Crude oil prices have risen above US$25 a barrel since the end of March. And while the price would probably have to increase beyond US$30 to undermine the recovery, the Fed is unlikely to take any chances, economists said. A 1999 study by the Fed showed that a sustained US$10 a barrel rise in imported oil prices cuts economic growth by 2/10 of a percentage point in the first year afterward and another 2/10 point in the second.

Each 10 percent increase raises the cost of doing business in the US by 2/3 of a percentage point, the study showed. Consumer-product manufacturers such as Procter & Gamble Co, Kimberly-Clark Corp, Dial Corp and Newell Rubbermaid Inc are among companies that will pay more for oil-based chemicals used in their products, analysts said.

Some Fed officials have taken notice of the price increases.

Before oil futures peaked April 2, central bankers were expressing a willingness to take their time raising rates.

The run-up in oil prices is "a new and not so favorable element in the overall economic picture," Al Broaddus, president of the Richmond Federal Reserve Bank, told reporters last week. He said the gains so far weren't enough to throw the US back into recession. Fed Chairman Alan Greenspan is likely to give his assessment when he appears next week before the Joint Economic Committee of Congress.

The price of oil for May delivery rose almost 4 percent Monday to US$27.23 a barrel on the New York Mercantile Exchange after Iraqi President Saddam Hussein ordered a 30-day halt in sales to protest Israel's occupation of Palestinian areas. The May delivery price today fell to US$25.82 after Saudi Arabia pledged to make up for any supply shortage. Last week oil futures touched US$27.71 a barrel.

The increases are less dramatic when viewed over a longer period. The price of crude has averaged US$24.21 a barrel over the past year. It dropped to a low of US$17.45 on Nov. 15 after rising as high as US$29.98 on May 21, when the US was about two months into the recession.

The US Energy Information Administration, an arm of the Energy Department, predicted that US oil prices would average US$25.76 a barrel in the second quarter.

Prices may be about US$2 a barrel higher than that if Iraq carries out its threat to suspend exports for the full month, said Derriel Cato, an oil analyst at the agency.

Treasury Secretary Paul O'Neill said that the price of oil is in an acceptable range and "I don't know anything that suggests it's going to go higher." The Fed can afford to wait to raise rates because the economy isn't at a stage where inflation poses a risk, analysts said.

One concern is whether oil-producing countries heed the call by Libya and Iran for an oil embargo against Israel's supporters. An Arab oil embargo sent the US economy into recession in 1974.
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