Crude Prices Rise on Unrest

(22.02.2011) The unrest in Libya sends crude oil prices and the USD up and stocks and long-term treasury yields down.

By Kyrre Magnussen, Senior Economist at DNB Markets

oil productionThe U.S. markets were closed yesterday due to President's Day and this seemed to ease activity in other markets. Since yesterday morning long-term government bond yields fell for U.S. Treasuries and German Bunds. The USD has appreciated on a broad basis. The NOK has been roughly stable versus the Euro, while EURSEK is up 0.4 per cent.

Brent crude oil prices traded above 108 USD/brl yesterday. This is also the case this morning. In Asia stock market indices are falling and S&P500 Index futures are going the same way.

The common source to this development is of course the unrest in Libya. Libya holds Africa's largest oil reserves, and produced in August 1.73 mill barrels per day, OPEC's 8. largest producer. An earthquake in Christchurch, New Zealand, contributed to lower stock prices and weakening the New Zealand Dollar.

The euro-zone PMIs rose further in February. The composite index was up 1.4 points to 58.4, well above median expectations of 56.9 and long-term average of 54,6. Both manufacturing and service sector indices improved, the former driven by Germany, and the latter by France.

Also the German IFO index increased significantly in February, versus expectation of an almost unchanged index. The current situation index was the main contributor, while expectations were flat. The sub-indices were up for manufacturing, construction and wholesales, but down for the retail sale sector. February’s euro-zone PMI and German IFO surveys suggest that the euro-zone and German economies have started the year very well.

The rise in the composite PMI index to its highest level since June 2006, points to quarterly GDP growth of around 1.0 per cent, far stronger than Q4’s 0.3 per cent gain. But note that the index has recently over-predicted GDP growth. Meanwhile, the rise in the German Ifo main business climate indicator to a new record high suggests that the economy is expanding at an annual rate of 6 per cent or more, significantly stronger than Q4’s 4.0 per cent rise. In all, then, further evidence that the euro-zone and German economic recoveries may have regained momentum at the start of the year.

Axel Weber, departing Bundesbank governor, wrote yesterday an article in the Financial Times. Mr Weber rejects the idea that European rescue funds should have the power to buy government bonds in the market – a suggestion that has been backed by the European Central Bank’s governing council, on which he sits. "First and foremost, it is up to the member countries themselves to consolidate their public budgets and to initiate comprehensive economic reforms. Financial assistance is a supplement to buy some time and to smooth this process. Against this backdrop the existing instruments for short-term crisis resolution are adequate and, despite repeated demands to the contrary, should not undergo significant adjustment" Weber says.

Even in a crisis, the individual responsibility of countries for their finances should not be diminished, Mr Weber argues.

Yesterday we published revisions of our interest rates and exchange rates forecasts. Most changes are small adjustments but for key policy rates in UK and Sweden we made some new assessments. Last week Bank of England released its Inflation Report, indicating inflation slightly below target on a medium-term horizon based on market's forward interest rate curve. The short-term risk for high inflation and possible drift of inflation expectations bode for early rate hikes. We find that signal very clear, and expect now rate hike both in May and in August. After that we expect policy rates to remains unchanged until mid-2012. For SEK we now expect the Riksbank to increase signal rates three times this year. That is less than priced in to the market rates and less than the Riksbank's signal of four hikes. We believe high interest rate differential to EUR, low ERUSEK and declining home price growth will contribute to dampen the speed of rate hikes in the latter half of this year.