Bank of England weighs up risks of plunge in oil prices

Tumbling oil prices could expose the financial markets to geopolitical risk, create problems in the junk bond market and cause deflation, the Bank of England has warned.

In its half-yearly assessment of the dangers facing the financial system, Threadneedle Street said lower oil prices were largely positive for consumers and should support economic growth in the UK and worldwide.

But it said there were potential risks to financial stability if the low oil price, down 40% since June, was sustained.

Mark Carney, the governor, said: “Overall this is a net positive. The risk around the oil prices only really starts to become material if they breed further contagion.”

He said a sustained low oil price could have an impact on US shale oil and gas exploration companies, which might find it more difficult to maintain repayments on their loans.

These businesses have issued 13% of all outstanding junk bonds in the US and investors could race to sell off their holdings if they felt repayments were under threat. This could also have a knock-on effect on the wider junk bond – or high-yield – market.

There are signs that the junk bond market is already being hit by the falling oil price, with measures of risk attached to loans rising last week. The fall in oil prices is in part due to increased shale production in the US, where companies have been funding their activities through issuing debt on the bond markets.

Oil prices are at a five-year low following the decision by Opec, the oil producing cartel, not to cut output despite a plentiful supply.

The fall in the price of oil is also having a serious impact on the Russian economy, where the rouble is in turmoil, hitting historic lows against the dollar.

“A sustained lower oil price also has the potential to reinforce certain geopolitical risks,” the Bank of England said.

With the risk of deflation stalking the eurozone, the fall in oil prices could cut expectations for future inflation.

“This in turn could result in slower rates of growth of nominal incomes, increasing the burden of existing debts,” the Bank of England said.

But Carney said that the lower oil price was already feeding into lower prices in the UK and. He was speaking just as the ONS had released data showing inflation was at its lowest level for 12 years. The inflation rate was 1% in November after being 1.2% in October and below the 2% target rate for price rises.

“We should be clear that the 40%-plus drop will flow quickly through to consumers and increase real disposable income and is a net positive for the UK economy,” Carney said.

Powered by article was written by Jill Treanor, for The Guardian on Tuesday 16th December 2014 18.19 Europe/London © Guardian News and Media Limited 2010


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