Oil price drop too little and too late

Oil price drop too little and too late
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First Published: Sun, Jul 27 2008. 10 42 PM IST

Updated: Sun, Jul 27 2008. 10 42 PM IST
A barrel of oil cost less than $124 (about Rs5,230) on Thursday, a 15% fall in just 10 days. For those worrying about rising prices, the declining trend is welcome, despite Thursday’s tiny bounce. But it is too little and too late to slow inflationary pressures much.
Sure, upward pressure on petrol prices should ease within days or weeks. But they will still be high. After all, the crude oil price has only dropped back to where it was two months ago—when it seemed almost unbearably expensive—and is still roughly 70% more costly than a year ago.
Also, while oil prices are softening, other energy-related prices are rising. Natural gas contracts mostly follow the oil market, but usually with a six-month lag. Electricity price hikes are even slower, as they mostly require regulatory approval. And consumers will eventually pay for more expensive oil in everything from plastic packaging to imported Christmas tree ornaments, but it can take a year or more.
This gradual effect can be seen as a simple process of inventories working through the system. But there may also be a subtler monetary undercurrent, as economists Frank Browne and David Cronin of the Central Bank and Financial Services Authority of Ireland have argued.
When money supply expands, customers bid up prices across the board. Historically, commodity prices have been the first to rise, because they are the most flexible. But the two economists suggest that other prices have followed, even when commodity prices fall back. Eventually, everything ends up costing about the same proportion more than before the money supply increased.
One price is particularly important for future inflation—the price of labour. If workers can negotiate pay hikes that keep up with the cost of living, they will keep the inflationary ball rolling. It looks like employees will be able to collect lots of evidence over the next few months to support their case.
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First Published: Sun, Jul 27 2008. 10 42 PM IST