Global Economy Gets Tailwind From Falling Energy Prices

FRANKFURT—Energy prices are roiling the global economy for the second time in a year. 
This time, it’s good news. Plunging oil and natural-gas prices are pumping up economic growth, putting money into consumers’ pockets, boosting confidence and easing pressures on government budgets.
It is the reverse of the energy-price shock a year ago, when Russia’s invasion of Ukraine raised concerns about a deep recession in Europe and beyond. 
Declining energy prices go some way toward explaining this year’s unexpectedly strong economic data in the U.S. and Europe, economists say. Supply-chain managers on both sides of the Atlantic are more optimistic than they have been in many months, according to business surveys by S&P Global, a closely watched indicator of future growth. 
The windfall for households, businesses and governments is offsetting higher borrowing costs as central banks push up interest rates to cool historically high inflation.
The price of a barrel of oil has fallen by more than a third since the middle of last year, to about $77 from $121, below its prewar level, as markets adjusted to Western embargoes of Russian supply and as oil was released from emergency reserves. Some economists warned a reopening Chinese economy would push oil prices higher, but that hasn’t happened yet.
In Europe, benchmark wholesale natural-gas prices have slumped by almost 90% since last summer, reaching their lowest since 2021, thanks to warm weather, conservation and increased imports.
Energy goes into almost all goods and services, giving it outsize importance even though advanced economies have reduced the energy consumed per unit of output since the 1970s.
“It’s difficult to overstate how important this is in terms of the macroeconomic outlook for Europe,” said Neil Shearing, chief economist at Capital Economics in London.
For Europe, declining natural-gas prices represent enormous cost savings, equal to about 3.5% of gross domestic product this year for Italy, and about 2% of GDP for Germany, Portugal and Spain, according to Capital Economics. 
The effect on output, though, is complicated by hundreds of billions of dollars in subsidies governments rolled out last year to cushion the blow to households and businesses. Those subsidies attenuated the impact of the rise, and therefore the subsequent fall, in energy prices. For that reason, the impact on output will be about half the actual cost savings, Mr. Shearing said. “We’ve moved from a situation where we were expecting quite a deep recession to expecting a mild, shallower and shorter-lived one,” he said.
The energy stimulus could boost eurozone output by around 1.5%, roughly equivalent to a year’s worth of growth, according to Capital Economics and Berenberg Bank. The eurozone economy is now expected to grow by 0.7% this year, compared with an October forecast for a 1.3% contraction, according to Berenberg. The U.S. will benefit as well to a lesser extent, economists said.  
Consumer confidence has rebounded strongly on both sides of the Atlantic in recent months, reversing last year’s declines. That might mean households spend more of the money they saved during the pandemic, boosting growth further, economists said.
Across Europe, the shock to household and business confidence last year was at least as significant as the hit to households’ disposable incomes, said Holger Schmieding, chief economist at Berenberg Bank.
In Italy, which depends heavily on natural-gas imports, retail sales jumped by 1.7% in January from December. That was among the fastest increases since May 2020, when economies were reopening after pandemic lockdowns. In Germany, production in energy-intensive sectors surged by 6.8% in January from the previous month, after plunging by one-fifth last year, according to the federal statistics agency.
“It was only the gas price explosion and concerns of gas shortages prevalent over last summer and winter that brought the eurozone to stagnation last year,” said Mr. Schmieding. “This shock is now going into reverse.”
Unlike Europe, where higher energy prices transfer money from locals to foreigners, the U.S. is a net energy exporter. Higher prices therefore have more ambiguous effects: They redistribute money from American households to American energy producers and their shareholders.
However, households are more likely to spend than oil producers, meaning even in the U.S., higher oil prices on net subtract from growth. A doubling of oil prices that lasts for a full year cumulatively reduces real household spending by up to 3.7%, according to Morgan Stanley.
Conversely, the decline in gasoline prices in the second half of last year more than offset the effect of higher interest rates over the same period by freeing up disposable income, the bank said. 
In many countries, governments provided wider support alongside subsidies per unit of energy use, including cash handouts. In the U.K., households are receiving a flat payment from the government, worth £400, equivalent to about $480. In France, the government increased income tax bands to boost disposable income.
Major central banks are trying to gauge how much further to raise interest rates. The fall in energy prices cuts both ways. On the one hand, it lowers headline inflation. As a result, unions may come under pressure to settle for lower pay gains, lessening the risk of a wage-price spiral. 
On the other hand, lower energy prices act like a tax cut, boosting consumer spending, which might add to inflation pressure outside of energy.  
“What [households] aren’t spending on energy, they’re going to spend on something else,” Catherine Mann, a member of the Bank of England’s Monetary Policy Committee, said in a panel discussion last month.
“That translates something that I do not control, which is external energy prices, into something that looks a whole lot more like what I’m supposed to control, which is domestically generated inflation.”

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