By Frank Schnaue

01-06-04 The recent surge in the price of crude oil is not expected to be painless, but economists at Standard & Poor's Corp. expect the $ 10 hike will only chop about one-quarter percentage point off the gross domestic product's expansion for the year.
Standard & Poor's Corp. Chief Economist David Wyss, said, "The recent surge in oil prices has rattled financial markets, sparking fears of an inflationary squeeze on the economy similar to the one that occurred in 1980. We at Standard & Poor's Economics believe that while the rise in prices is cause for concern, it's unlikely that 2004's economy will suffer the same kind of damage caused by earlier oil shocks. Higher energy prices should, however, slow the current US recovery," Wyss said.

Economist said that the economy in 2004 is expected to grow at a sustained and strong pace. Forecasters also expect that the new signs of life found in the employment sector during the final months of 2003 will continue at a pace strong enough to push down the unemployment rate.
Many economists believe 2004 may also be the year in which the Federal Reserve will finally be able to become confident enough in the recovery to hike short term interest rates from their 1 % level, albeit by only a small amount. Federal Reserve Chairman Alan Greenspan in his a semiannual report on monetary policy to Congress said, "The odds of sustained robust growth are good, although, as always risks remain."

Experts on Wall Street are expecting the Fed to hike short term rates a quarter-percentage point to 1.2 % at the central bank's June policy-making meeting. And the next tightening move after that is likely to come a bit quicker than expected -- probably before the November election. The fed-funds rate is likely to be 1.75 % and possibly 2 % by yearend.
"We expect a hike of three percentage points in the benchmark rate, to 4 %, over the next two years," Wyss said.

Meanwhile, the Commerce Department recently issued its best measure of the economy, as measured by the Gross Domestic Product. The government revised its first quarter GDP reading upward to 4.4 % from a 4.2 % annual rate after growing at a slower 4.1 % clip during the fourth quarter of 2003.
The major contributors to the increase in real GDP in the first quarter were personal consumption expenditures, equipment and software, private inventory investment, federal government spending, and exports. Imports, which are a subtraction in the calculation of GDP, increased.

The slight acceleration in real GDP growth in the first quarter primarily reflected a deceleration in imports, and accelerations in federal government spending and in personal consumption expenditures that were partly offset by decelerations in exports and in equipment and software.
Economists noted the GDP is the broadest measure of aggregate economic activity and encompasses every sector of the economy. Experts said while the first quarter growth rate was a healthy pace, it appears downright modest after the 8.2 % growthpace recorded in the third quarter of 2003.

Real GDP growth is always quoted at a quarterly annual rate. It measures how much the economy has grown over a three-month period. Quarterly growth rates are often volatile; consequently, economists also like to look at the year-over-year growth in GDP. The yearly changes tend to be more stable.
The GDP report contains a treasure-trove of information which not only paints an image of the overall economy, but tells investors about important trends within the big picture. GDP components like consumer spending, business and residential investment, and price (inflation) indexes illuminate the economy's undercurrents, which can translate to investment opportunities and guidance in managing a portfolio.

Looking at the price of crude, Wyss said, "A perfect storm of heavy demand from China and the US and fears of Middle East violence disrupting supplies drove prices for the benchmark West Texas Intermediate grade of crude oil to $ 41.65 a barrel on May 24.”
The markets in the United States reopened after the long Memorial weekend and investors were faced with oil prices surging on global markets after a deadly attack in Saudi Arabia that raised concerns about oil-supply interruptions. Oil prices climbed in New York by $ 1 a barrel after the attack killed 22 people in the Saudi oil hub of Khobar, while oil ministers began gathering in Beirut, Lebanon, to debate a possible production increase.

The attack added to fears about the security of oil supplies from Saudi Arabia, the world's largest exporter. Experts said the odds OPEC will be able to quell crude prices when it meets in Beirut appear to have dramatically lengthened following the terror attack on foreign oil workers in Saudi Arabia.
The attack is likely to underscore a belief among many in the oil markets that unrest in the region warrants the hefty risk premium on crude oil -- some estimate it as high as $ 10 a barrel -- that has driven prices to record highs.

OPEC, under pressure from governments around the world anxious about the impact of $ 40 oil on their resurgent economies, now faces the task of reassuring customers it still has some control over prices. OPEC's oil ministers are gathering in the Mediterranean city of Beirut to discuss raising quotas or even temporarily suspending the self-imposed limits altogether to signal to the markets that supply won't be allowed to fall short.
"We think the geopolitical uncertainty has resulted in a more than a risk premium of more than $ 5 a barrel on top of already-high prices," the economist said. "Peak crude prices in recent days have been much higher than the $ 39.94 average we expected for May and are 60 % higher than their recent annual low average of about $ 25.90 a barrel in 2002. Based on the May 24 price, crude is nearly 44 % above the $ 29 average level of the last three years," Wyss said.

Experts said the recent run-up in crude prices is still a risk for the economy, but not to the extent feared by investors. While higher oil prices indirectly tax consumers, squeeze corporate profits, and raise prices everywhere, the impact should be less severe than before. That's because energy consumption relative to gross domestic product is lower than in the early 1980s.
Household spending on energy in the first quarter is expected to be about 4.9 % of real disposable income. This is up from 4 % two years ago, but well below the 8.1 % seen in 1980.
"Moreover, the transition from a manufacturing-based economy to one in which services and information technology are predominant has reduced America's reliance on oil. Our models at S&P show that a $ 10 increase in oil prices will result in an expected 0.25 % decrease in GDP growth for the year," Wyss said.

Still, though the economy is more energy-efficient than it was during the Carter Administration, the impact of rising oil prices will be significant.
Wyss said, "We expect the energy spike to reduce consumer spending by about $ 50 bn in 2004. Consumers, after shelling out more cash at the pump, will likely shy away from other purchases. Company profits will also be squeezed, at least for oil-guzzling industries such as airlines and chemicals."

Source: United Press International