How Much Can Oil Prices Influence the Euro Zone Economy?

Since the end of 2004, euro denominated oil has risen by nearly 300%. Although the increase in energy prices is not as significant as in other parts of the world, we expect it to start putting downward pressure in the Euro Zone economy in the second half of 2008.

Indeed, high oil prices have pushed headline inflation for the Euro Area to a record 4 percent in June, which is more than double what the European Central Bank's defines as price stability. Furthermore, second round effects of elevated energy prices are already visible in all sectors of the Euro Zone economy. For instance, core inflation which excludes goods like gasoline, increased to 2.4% primarily because of an increase in the price of processed food and airline tickets. Second round effects may also be reflected in salaries growth. In general, if employers expect higher inflation, they may also think that they can lift up their own output price and therefore increase the wages which could create an inflation spiral. In addition, the higher price of consumer goods is already causing a reduction on real disposable income, reducing both private consumption and business investment.
Yet, not everything is bad news for the Euro Area. In fact, the world's largest economic block exports a lot of high-end manufacturing and luxury brands which are not price sensitive and are in great demand from emerging markets.  For instance, the OPEC group and Russia combined source almost 25% of their total imports from Euro area compared with only about 7% from the US. Nonetheless, exports of other types of products may also get affected as higher oil price lifts the cost of products send abroad and eventually make them less competitive.

Anna Fedec,
7/15/2008 2:49:10 PM