Soaring oil 'a major threat to growth'

SOARING oil prices have the potential to wipe out any moderate recovery in the UK economy over the next two years, a leading think-tank warned today.

Experts at the highly regarded Ernst & Young Item Club said a sustained oil price of $200 a barrel could slash GDP growth – to just 1.2 per cent in 2010.

That compares with the group's spring forecast for 2.7 per cent growth two years from now – a projection based on oil prices hovering just below $100 a barrel.

E&Y also warned of the potential impact on manufacturing from sky-high fuel costs, believing the sector could move into recession by 2010, recording a 0.3 per cent fall in output, against current forecasts for 1.8 per cent growth.

The think-tank's gloomy scenarios follow Opec president Chakib Khelil's recent warning that the price of crude could keep rising to top $200 a barrel.

Last night, oil futures broke through the once unthinkable price of $120 a barrel. Oil reached its latest milestone amid threats to overseas crude supplies.

Oil prices have risen by about 400 per cent in the past seven years and by 25 per cent in the first four months of 2008 alone.

Even at $150 a barrel, E&Y calculates that economic expansion, manufacturing output and export trade would take a hammering.

Item Club economist Hetal Mehta said: "The modest upswing Item was predicting over the next couple of years in GDP growth is predicated on an oil price remaining below that of $100 per barrel.

"If this increases to $120 or $150 in the long term, this has serious implications for the strength of the wider economy. If it hits $200 per barrel then, frankly, all bets may well be off."

Today's report also contains a stark warning for the Bank of England as it tries to keep a lid on inflation.

The Item Club's projections based on an oil price of $150 have the CPI measure of inflation hitting 4.3 per cent in 2009 before easing to 3.9 per cent the following year. At $200, those figures soar to 5.9 and 5.3 per cent, respectively.

The central bank, whose monetary policy committee meets this week to decide on interest rates, is charged with keeping CPI inflation at 2 per cent.

A rise above 3 per cent would need a letter to the Treasury from BoE Governor Mervyn King explaining what the bank will do to cool price growth.

Based on oil remaining at about $120 – around its current level – E&Y predicts inflation of 3 per cent this year, up from its spring forecast of 2.7 per cent.

Mehta added: "With oil permanently at $200 per barrel, the Governor of the Bank of England would be suffering from writers' cramp with the number of letters he would have to write to the Chancellor.

"Item predicts that the $200 scenario could potentially nearly treble the headline inflation rate next year from just over 2 per cent to 5.9 per cent.

"Whilst that is hardly a return to the rampant inflation of the 1970s and 1980s, it would be a worrying trend after the tight control central banks have kept on inflation in recent years."

Mehta said there was "a major mismatch" between oil supplies and demand. "Opec members appear unwilling or unable to raise their output whilst the thirst for oil particularly in developing countries appears to be unquenchable," he said.

The Item Club claims to be the only economic forecasting group to use the Treasury's own model of the UK economy.