Higher Gas Prices Could Test Economy

The price at the pump is nearing the highs seen last spring, but the spike may reverse as the market recovers from Isaac.

Milton Ezrati of Lord AbbettGasoline prices have risen almost back to the highs seen last spring, although there’s been remarkably little coverage. Such a move will affect the economy, whether or not it’s noted in the headlines, especially if the higher prices stick. The experience last spring offers a model of what to expect. If the spike is short-lived, as it was then, the economy will show brief signs but quickly correct. If prices remain elevated for a period of months or rise farther, the pace of real economic growth, already anemic, will suffer. In time, the impact on general price levels could constrain the Federal Reserve’s ability to consider further monetary ease.

The immediate picture is far from pretty. In the past few weeks alone, the national average retail price for a gallon of gasoline has risen almost 11%, from a low of $3.36 in late June to about $3.75. That is only 5.5% below the $3.94 high last April. In higher-tax states, such as Connecticut and California, the price per gallon has already topped $4, as it did last spring. Since the increase in retail prices so far has failed to keep up with the 20% rise in wholesale gasoline prices and the 27% jump in crude oil, chances are the price at the pump will move up still more in coming weeks.

The second wild card is Iran. The tension related to Iran’s nuclear ambitions has hung over the world oil supply outlook for some time now. It was such tension that prompted last spring’s price spike, and a renewed concern about action in the Persian Gulf contributed to this most recent price rise. Should Israel strike Iran, as some suggest it will, even before the American elections this coming November, supplies from that important oil region would stop flowing, not just from Iran, which already has lost most of its markets, but also from Iraq, Kuwait, Bahrain, Qatar and the oil Emirates, all of which ship through the Persian Gulf. Even events far short of an Israeli strike could disrupt supplies. If a desperate Tehran, for instance, declares the Strait of Hormuz closed, the supply could stop as surely as if there were actual fighting. Even if Iran’s navy could not enforce such an order, the threat could still shut down oil flows by prompting insurers to back away.

Though such geopolitical events cannot be forecast in any sense typically used in finance, they are nonetheless real. What is more, should such problems in the Persian Gulf, or even less dramatic events such as calm in Europe or a pickup in the pace of growth anywhere in the world, sustain or extend recent price increases, the effects on the U.S. economy are all too predictable.

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