Oil spike to throw up clear trends in currency movements

As the price of crude oil heads inexorably towards $120 a barrel, some clear winners and losers are emerging in the currency markets. Those most likely to benefit will obviously include the currencies of countries that are energy producers, such as the Canadian dollar and the Norwegian krone.

However, others that will gain include those currencies of countries that are more likely to respond to the higher energy costs with higher interest rates.

“Currency moves will depend upon the relative policy responses – central banks, such as those in Europe, which are committed to tackling inflation problems are more likely to see their currencies appreciate relative to others,” said David Wood, head of global foreign exchange strategy at Barclays Capital in London.

This could put the euro at the forefront of the winners.

Meanwhile, the negative impact that higher crude prices have on global growth projections, along with the damping effect this will have on equity market sentiment, is likely to take its toll on carry trades, ensuring the low-yielding currencies find themselves back in favour, largely at the expense of more risky high-yielders.

But it is the dollar that many fear will pay the price for higher crude.

In a recent study, Barclay’s Wood described the dollar as facing a “vicious circle” as dollar weakness contributes to higher energy prices as oil exporters seek compensation for their lower dollar earnings and investors flock to commodities as an insurance against inflation.

Despite hopes the rally in crude might run out of steam as it headed over $100 a barrel and into uncharted territory, there appears very little sign of a serious pullback.

Jan Poser, chief economist with Sarasin, also in Zurich, said although he does not expect the inflationary pressure from higher crude prices to last that long given the weakness in the global economy, “it is currently severely undermining the purchasing power of private households and wiping out the meagre increases in salary”.

But while policymakers in the US remain more concerned about growth, as the US housing market continues to deteriorate and rate cut expectations rise as the next Federal Reserve meeting comes into view at the end of this month, those in the euro zone remain hawkish about inflation pressures.

Earlier this week, several members of the European Central Bank suggested instead of contemplating a cut in rates, the bank could well start looking at rate hikes now. For currencies related to oil producing economies, such as the Canadian dollar and the Norwegian krone, the benefits of the crude rally are pretty clear-cut. However, in both these cases, currency support could also come from interest rates. (Dow Jones Newswires)