[LehmanBr]

Within 5 months oil prices have doubled from a trough in the mid-30’s to almost 70$/pbl currently. These are the levels broadly observed in 2007. Going forward analysts expect ongoing escalation of commodity prices towards the mid-90’s by late 2010.

The obvious concern that this oil price rebound has generated is whether it will prove to be detrimental to the global economic stabilization and gradual recovery. There are two main expressions of this worry:

1) First, at least in G3 space, final demand remains quite weak. Higher oil prices could potentially eat out from the disposable income of households and reduce their levels of consumption for other goods.

2) Relatedly, the empirical evidence from 2008 suggest a strong negative correlation between higher oil prices and consumer confidence. Although the risks to demand stemming from higher oil prices are not negligible, it is worth putting the oil price increase in context before becoming overly concerned. The increase in oil prices has come as a result of economic stabilization and market expectations of some recovery especially in the emerging world. In that sense, it is an endogenous development for markets.

What this practically means is that it has coincided with growth positive developments like the rebound in equity markets and the relaxation of money market and other funding tensions.

Another important implication is that if there were signs of fresh deceleration in demand then there would also probably be some relaxation in commodity price pressures. The recent oil drop of 12$ from highs of 72$pbl is indicative. It came at a time where the market re-priced its growth expectations lower, thus re-adjusting prices for all growth-sensitive assets lower (including oil).

Finally, it is also worth bearing in mind, that this pick-up in commodity prices is coming at a time where price trends in other parts of the economy are either stale or declining. This means that there is an element of relative price adjustment taking place, with higher commodity prices compensating for lower prices in other parts of the economy. In this case, oil prices can play a stabilizing role for CPI: they are unlikely to lead to intense inflation pressures, while at the same time they can help support headline inflation despite broader disinflationary pressures.