Ready for lift-off?
15 May 2018
Rising oil prices are normally bad news for Developed Asia given its dependence on oil imports (see Chart 8). Rather unusually, the recent oil price rise has occurred in conjunction with a rising dollar – implying that the effects should be amplified outside the US dollar zone. So how will the rise in energy prices effect the region’s economies and what are the implications for inflation and policy settings?
Let us start by looking at the corporate sector. Though less exposed to upstream components, a number of developed Asian economies are surprisingly integrated into the global energy supply chain. South Korea is a noticeable beneficiary of energy capex, particularly in the Middle East, through both shipbuilding and construction services. In Singapore, higher oil prices may ease the plight of the marine and offshore engineering sectors. Offsetting the positive for oil-related exports are concerns about margins more generally. An erosion of pricing power has limited firms’ ability to pass on costs and has served to subdue wage growth in the region. If corporates are similarly forced to wear energy costs the implications for margins could be material. We do think that firms are more insulated to energy shocks than in the past due to a reduction in oil dependency and the level of energy intensity. Japan has a clear advantage here, while Taiwan remains relatively oil hungry (see Chart 9). The story for the household sector is clear cut. A combination of weak real income growth, elevated savings rates and ageing demographics has meant that consumption has persistently disappointed. The effects of policies designed to promote consumption-led growth in the region, such as the hikes in minimum wages and expansion of social security provision, are still nascent, making an energy-led real income squeeze untimely. So far consumer confidence has held up ok but developments here are worth closely monitoring.
Turning to the inflation effects, let us first try to quantify the impact before considering the implications for policy. Judging by the weightings of energy in CPI, Japan is likely to see the biggest impact (7.8%) followed by a more modest impact for Taiwan (4.3%) and Korea (4.2%) and finally Hong Kong (2.4%). It is worth tackling Japan’s case in some detail. Based on recent history, a $10 per barrel rise in oil will push up CPI by some 0.3%. Consequently, we expect inflation to accelerate later this year, having stalled around 1%. However, we would be cautious about claims this provides evidence inflation is on its way to the 2% target. Core-core inflation is stuck at 0.3% y/y, while the Bank’s preferred underlying measure is just 0.5% y/y. Furthermore, the last temporary spike in inflation, driven largely by 2015 yen effects, backfired spectacularly as households retrenched due to the real income squeeze. The hope is the economy is better placed to allow wages to adjust accordingly. However, delays to workstyle reform legislation have reduced conviction here. Consequently, we suspect that any move to adjust policy due to a temporary increase in energy prices is likely to be viewed as a capitulation, pushing the yen significantly higher. In contrast, core inflation measures elsewhere in the region are all firmly ensconced above 1%, providing a better platform for rates lift off than in Japan. Indeed, if growth effects are modest the pick-up in headline inflation may provide a useful excuse to begin to normalise rates.