By Raj Rajendran
A recession could be staring the world's major economies in the face by next summer if history repeats itself and a 30-year rule holds true that output slumps after oil prices spike.
Optimists say the old relationship is dead, that companies are more competitive, energy efficiency is ingrained into corporate culture and today's high oil prices are driven by huge demand.
But others say the link between the four big oil price spikes of the past three decades and industrial production in the world's biggest economies means recession is inevitable after a year-to-date 70 per cent surge in oil prices.
"The percentage increase from previous levels show the same pattern as the present one," Dieter Wermuth, consultant to UFJ Bank and partner of Wermuth Asset Management said.
"In the previous cases, such oil price increases were followed by a recession and one could come, even though the oil price increase is the result of a booming economy," he said.
US light crude oil prices hit a record of $55.67 a barrel on Monday.
The strong inverse relationship between oil and US and German industrial production has been observed since 1973, and confirmed in 1981,
1991 and most recently post September 11.Recent moves in industrial metals prices also appear to support the view that the global economy is slowing more quickly than expected, especially after a sharp sell-off last week.
"If this sell-off were to gather momentum, it would provide one of the clearest signs yet that global growth might be about to enter a slower pace," said Merrill Lynch chief global investment strategist David Bowers.
Investors have cut speculative positions on the London Metal Exchange, with total open interest for LME metal and product contracts sinking by about 10 per cent to around 800,000 lots in the week ending October 22.
But others play down the risks. "Higher oil prices have less effect on the industrialised economies than they had some decades ago, and the recent hikes have only marginally slowed growth in the major OECD economies," the OECD said in a report entitled Financial Market Trends.
Like the OECD, many private sector economists expect red-hot oil prices to shave robust global growth by only about 50 basis points next year.
They say the industrialised world's substantial services sector is another factor balancing out the impact of higher oil costs on the comparatively small, albeit energy-intensive, manufacturing industry.
They also say the absence of inflation and low wage growth show that he risks to economic expansion remain muted. Mr Wermuth disagrees and says if policy makers fail to trigger counter-cyclical rate moves when the need arises, a recession cannot be ruled out.
He expects the US Federal Reserve to pause in its rate tightening cycle after an increase at its November meeting and sees no hikes from the European Central Bank anytime soon.
"When you have such high oil prices it's not just investment but consumption that will be affected," Mr Wermuth said.
More analysts are coming to this view on the back of slowing consumer spending.
"We see US consumer spending growth slowing to 2.7 per cent in 2005 from what looks to be a 3.5 per
cent advance this year. This would represent the softest pace since
2001 and second weakest since 1995," said Merrill Lynch economist David Rosenberg.Retail sales in the euro zone and the UK are starting to show signs of fatigue with rising utility and heating oil bills set to crimp consumer spending further going into the winter.
Industrial production is still inching up in the United States, but is becoming patchy in the euro zone, falling 0.6 per cent in August after rising 0.2 per cent in July.
In the UK - which has been hiking rates since November 2003 to curb inflation risks that have worsened as oil has soared - manufacturing output fell for the third month running in August and at the sharpest pace in nearly two years.
Oil prices are unlikely to shed the bulk of their recent big gains due to several factors including the demand/supply imbalance, lack of spare production capacity and security woes in Iraq and the Middle East, experts say.
Demand for oil in fast-growing China and India shows no sign of slowing either and that means prices are set to stay high - further exacerbating the problems of industrialised economies.
"They will keep oil prices high even if we get a slowdown in the US," Mr Wermuth said.