Energy Prices Fall, Giving The Global Economy A Boost

The global economy is in turmoil due to energy costs for the second time in a year.

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It's good news this time. Prices for natural gas and oil are falling, which is accelerating economic development, putting money in consumers' pockets, increasing confidence, and relieving strain on government budgets.

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It is the opposite of the energy price shock from a year ago when fears of a severe recession in Europe and abroad were sparked by Russia's invasion of Ukraine.

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Economists contend that falling energy costs partially account for this year's surprise positive economic indicators in the U.S. and Europe. According to company surveys by S&P Global, a frequently studied predictor of future growth, supply-chain managers on both sides of the Atlantic are more positive than they have been in many months.

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Due to central banks' efforts to lower historically high inflation, rising borrowing costs are being compensated by the windfall for individuals, businesses, and governments.

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Since the middle of last year, the price of a barrel of oil has decreased by more than a third, to roughly $77 from $121, below its prewar level, as markets adapted to Western supply embargoes on Russia and oil was freed from emergency stocks. Several experts cautioned that the oil price would rise if the Chinese economy recovered, but that hasn't occurred yet.

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Thanks to warm weather, conservation efforts, and increasing imports, benchmark wholesale natural gas prices in Europe have fallen by about 90% since last summer and are already at their lowest levels since 2021.

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Energy is used in practically all commodities and services, making it extremely important, even though modern economies have reduced energy use per unit of production since the 1970s.

"It's impossible to overestimate the significance of this in terms of Europe's macroeconomic outlook," said Neil Shearing, chief economist at Capital Economics in London.

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According to Capital Economics, falling natural-gas prices offer substantial cost savings for Europe, amounting to around 3.5% of Italy's GDP this year and about 2% of GDP for Germany, Portugal, and Spain.

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The impact on output, however, is exacerbated by hundreds of billions of dollars in government subsidies implemented last year to soften the hit to people and companies. These subsidies mitigated the impact of the rise in energy costs, and therefore the following decline. As a result, the impact on output will be around half of the actual cost reductions, according to Mr. Shearing. "We've gone from anticipating quite a deep recession to expecting a milder, shallower, and shorter-lived one," he added.

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According to Capital Economics and Berenberg Bank, the energy stimulus may raise eurozone production by approximately 1.5%, nearly equivalent to a year's worth of growth. According to Berenberg, the eurozone economy is now predicted to grow by 0.7% this year, up from a 1.3% decline in October. Economists predict that the United States will profit, but to a smaller amount.

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In recent months, consumer confidence has returned sharply on both sides of the Atlantic, erasing last year's dips. According to analysts, this might imply that people spend more of the money they saved during the epidemic, increasing GDP even more.

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According to Holger Schmieding, chief economist at Berenberg Bank, the blow to consumer and business confidence in Europe last year was at least as big as the cut to family disposable income.

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Retail sales in Italy, which is highly reliant on natural gas imports, increased by 1.7% in January compared to December. This was one of the fastest gains since May 2020, when economies reopened following pandemic lockdowns. According to the federal statistics office, production in energy-intensive industries increased by 6.8% in January compared to the previous month, after falling by one-fifth of the previous year.

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"It was only the gas price explosion and concerns about gas shortages that brought the eurozone to a halt last year," Mr. Schmieding explained. "This shock has now been reversed."

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In contrast to Europe, where increased energy prices shift money from residents to foreigners, the United States is a net energy exporter. Rising prices have more unclear impacts because they shift money from American families to American energy producers and stockholders.

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Nonetheless, because people are more inclined to spend than oil producers, rising oil costs reduce growth even in the United States. According to Morgan Stanley, a doubling of oil prices that lasts a full year cuts real family expenditure by up to 3.7%.

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The drop in fuel costs in the second half of last year, on the other hand, more than offset the effect of rising interest rates over the same time by freeing up disposable income, according to the bank.

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Governments in several nations offered broader support, including cash transfers, in addition to subsidies per unit of energy used. In the United Kingdom, households get a government payment of £400, which is around $480. In France, the government raised income tax brackets to improve discretionary income.

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Leading central banks are attempting to determine how far they may hike interest rates. The drop in energy prices affects everyone. On one side, it reduces headline inflation. As a result, unions may face pressure to accept lesser pay increases, reducing the possibility of a wage-price spiral.

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Lower energy costs, on the other hand, function like a tax break, increasing consumer expenditure and perhaps adding to inflation pressures outside of energy.

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"What [households] don't spend on energy, they'll spend on something else," Catherine Mann, a member of the Bank of England's Monetary Policy Committee, said last month during a panel discussion.

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"It turns something I don't control, foreign energy costs, into something that looks a lot more like what I'm supposed to manage, locally created inflation."

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