Economy may avoid 'oil recession'

SOARING oil prices have historically been the surest harbinger of an economic slump. With the price of a barrel of Brent crude now at levels not seen since the build-up to the Gulf War in 1990, politicians and central bankers are getting twitchy.

Prime Minister Tony Blair last week said there had been a 'significant spike in demand' for oil, which history had taught could have a 'severe impact' on the economy.

The Bank of England monetary policy committee last week cited 'sharply rising commodity prices' as one of the reasons for lifting interest rates by a quarter-point to 4.25%.

The oil crises of the 1970s were held largely responsible for the crippling recessions that followed. The first, in 1973, was sparked by an oil embargo following the outbreak of the Yom Kippur War.

Fights broke out in long queues at petrol stations, and in the US there were odd-even days - based on the first digit on cars' number plates - dictating when motorists could fill up.

The second came in the aftermath of the Iranian Revolution in 1979 and was the forerunner of the 1981 economic slump. US President Jimmy Carter made symbolic efforts to encourage energy conservation, such as wearing a jumper and installing solar power panels on the roof of the White House and a woodstove in the living quarters.

So, with oil breaching $40 a barrel on New York's Nymex and topping $37 in London, will things be any different this time?

Most economists are cautiously optimistic. They cite a number of reasons. First, pump prices are influenced more by Gordon Brown's fuel duties than the vagaries of the energy market. Motorists pay 80p a litre for petrol but 60p of that is tax.

Second, with inflation at just 1.1%, a sharp pick-up in the overall price level as a result of higher oil prices looks remote. A lack of pricing power means manufacturers are unable to pass on higher raw material costs at the factory gate. Producers' input prices jumped 0.8% in April but output prices rose only 0.3%.

Third, because oil is priced in dollars, the greenback's decline against sterling has softened the blow of higher fuel costs for manufacturers. From their trough at the end of 2001, oil prices in sterling terms have risen around 54% against 90% in dollar terms.

Finally, the impact of higher oil prices on the overall economy has been reduced as the manufacturing sector has shrunk. Manufacturing accounted for 30% of the economy in the 1970s compared with 20% now.