Daily Commentary BY THE CURVE TEAM –

Oil Price Surprise

6th of January, 2021

An unanticipated update to the oil price surprised markets overnight.

OPEC’s disproportionate effect on the oil price has again shifted markets. For much of last year oil and OPEC were front of mind, as the oil price plummeted from the covid-19 induced demand shock.

At the beginning of last year OPEC unexpectedly did not reduce production to limit the price fall. They did reach an agreement on production cuts but delays in the agreement pushed the futures price of oil negative and indicated tension between Saudi Arabia and Russia especially.

Overnight Saudi Arabia agreed to cut production by 1 million barrels a day independently, while Russia increased production. Saudi Arabia is the largest oil producer of OPEC, so the update sent oil prices higher.

Oil is a big contributor to CPI data. If the price rise is sustained, CPI would be expected to rise more in line with the RBA’s target of 2-3%.

However, this would occur while unemployment remains much higher than pre-covid. The RBA’s shift since the pandemic to emphasising both inflation and unemployment, rather than a clear emphasis on inflation, will be put under the microscope under these conditions.

Supply side disruptions, such as China’s restrictions on our exports and continued covid disruptions risk more supply side led impacts on inflation, which could result in stagflation. Especially considering inflation will be coming off a lower base following the pandemic.

If stagflation eventuates, the RBA will have to choose whether to rein in inflation or keep rates low to assist unemployment. It is unclear what the RBA would prioritise, but given the RBA has said that unemployment is a ‘national priority’ it would seem contradictory to increase rates if unemployment had not come down significantly.

Josh Stewart

Associate - Money Market