FxWirePro: Cyclical effects of lower energy prices on UK and US CPIs

The OPEC and EIA reports today are most likely to provide fresh impetus for crude oil’s directional move; if the OPEC report shows that members have not kept up with the production cuts, there will possibly be heavy selling pressure on crude once more.

The annual inflation rate in the United Kingdom fell to 1.8% in January 2019 from 2.1% in the previous month and below market expectations of 1.9%. It was the lowest inflation rate since January 2017, mostly due to a slowdown in the cost of electricity, gas and other fuels.

Lower energy prices are expected to drive both UK and US annual headline inflation figures lower in the days to come. The UK headline rate fell to 1.8% as widely anticipated consensus below the BoE’s 2% target. 

We expect lower petrol and utility prices (the latter affected by the introduction of the energy price cap on 1st January) to reduce overall inflation by 0.1ppt and 0.2ppts, respectively. As the decline is primarily a result of lower energy prices, we expect the ‘core’ rate (excluding food and energy) to remain at 1.9%.

The production monthly report published last week reported an increase in US crude production by 1.8mbd YoY and 345kbd MoM. While the yearly growth remains high, it has definitely started to slow down since its highs noted in Aug'18. On a monthly basis, we underestimated the month-on-month growth in JPM’s models as they did not factor in such a rapid return for the GoM crude post the Hurricane Michael shutdown.

Despite the strong monthly crude production growth numbers printed, we think US production growth and even absolute levels will stabilize to reflect a slowdown in completions activity, stabilization in productivity gains, higher declines from 2017-2018 vintage wells that contributed disproportionately to 2018 production growth, the impact of lower oil prices on production growth from private operators, and seasonality.

Markets are clearly hawkeyed on Cushing inventories, which admittedly have risen counter-cyclically and could rise further given the seasonal turnaround. The slowdown in US production growth might not be visible yet in inventories as we enter seasonal maintenance; however, US crude imports from key countries such as Saudi Arabia and Venezuela have plummeted in recent weeks. Courtesy: OCBC research & JPM

Currency Strength Index: FxWirePro's hourly EUR is at 30 (mildly bullish), while USD is inching at -110 (which is highly bearish), at press time 12:10 GMT. 

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