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As the Opec cartel agrees to cut oil production, should central banks prepare for a rise in inflation?

Oil
Opec has actually agreed to cut output (Source: Getty)

David Morrison, senior market strategist at Spread Co, says Yes.

Crude soared on Opec’s announcement not just to freeze, but to actually cut production. Yet the upside momentum appears to have petered out for now. No wonder, given the lack of detail over who will bear the brunt of the proposed cuts and uncertainty concerning a possible exemption for Iran.

Opec has kicked those cans down the road to its November meeting. Crude prices are now little changed from this time last year. If Opec members not only agree to cuts but are then fully compliant (which seems unlikely given the cartel’s past history) then there could be upside to oil prices from here.

But even if oil stabilises around current levels, there should be some impact on inflation in the future. Bear in mind that between October 2015 and February 2016 WTI fell from $50 to $26 – a move of nearly 50 per cent. Consequently, there is a good chance that energy costs will push inflation higher from here, increasing the pressure on the Fed to hike before year-end.

Peter Hensman, global strategist on the Newton Real Return team at Newton Investment Management, says No.

Many investors continue to look for any catalyst for bond yields to increase, but most remain focused on how rising costs will lead to higher consumer price inflation. The announcement of a cut in production by Opec adds to this belief.

Yet just as low unemployment is supposed to have led to an increase in labour costs, which then feed through into higher prices being charged to consumers, the reality is that, in a world where policy has encouraged supply as well as demand, competitive pressures mean that cost increases squeeze profit margins and don’t create pricing power on their own. The alternative for a company is to see business walk down the street, or more likely click to another website.

If Opec can agree to a production cut, that could contribute to an increase in the oil price, but this is likely to redistribute disposable income from consumers to oil producers instead of increasing overall general pricing.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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