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    Oil rebound brings relief to markets but outlook remains uncertain

    Crude oil prices extended their gains on Thursday as the deal announced between OPEC and Russia continued to provide support. On Tuesday, OPEC members Qatar, Venezuela and Saudi Arabia agreed with Russia, a non-OPEC member, to freeze output at January levels in a bid to halt the freefall in oil prices.

    Markets were initially disappointed with the outcome of the Saudi- and Russia-led talks in Doha as the deal did not involve any production cuts. There were also fears of divisions forming within OPEC with Iran seen unlikely to agree to a freeze having just resumed exporting oil following the lifting of international sanctions in mid-January. However, Iran has welcomed the deal, despite saying that it would be “illogical” for it to freeze its production, and is likely to cooperate with OPEC to agree to special terms.

    Oil prices plunged to the lowest level since 2003 in January with WTI crude oil hitting another fresh low in February. US crude has recovered from $26.05 a barrel to back above $31, representing a rebound of about 20%. Brent crude has made a stronger recovery of about 30%, climbing from $27.10 to around $35 a barrel. In comparison, crude oil was trading around $100 a barrel only two years ago.

    Prices are expected to remain volatile as uncertainty lingers in financial markets about the health of the global economy and what, if any, further action oil producers will agree on in the coming months. It’s also not yet certain whether this week’s agreement will be fully implemented as it still needs the backing of other producers for the deal to go ahead. But markets were encouraged by signs of a more proactive approach by the world’s top oil producers to curb supply.

    Unlike in previous instances when the world economy boomed following a period of falling oil prices, the latest round of price drops has yet to significantly boost global growth. One reason for this may be due to the fact that the current price slump is more to do with weak global demand than excess supply. Major economies have been struggling to return to pre-crisis growth rates even after exceptionally loose monetary stimulus measures. Emerging economies have also been hit much harder from the latest slide in commodity prices as they’ve become over reliant on exports to China to sustain their growth rates.

    Many advanced economies are now entering a phase where a prolonged period of low inflation brought on by falling oil prices, threatens to lower longer-term inflation expectations. This runs the risk of countering the effect of low energy and fuel prices boosting people’s disposable incomes, which in turn raises consumer spending. If consumers start to delay purchases on expectations of prices coming down in the near future, this would create a deflationary cycle like Japan has been trapped in since the 1990s.

    Policymakers are therefore likely to welcome any respite in the slide in oil prices given the limited tools remaining at their disposal to spur inflation. It would also take the pressure off commodity-linked currencies which have followed commodity prices lower over the past two years.

    The Canadian dollar has come off a 13-year low of 1.4689 per US dollar in January to trade around 1.3670 today. The Russian rouble fell to an all-time low of 85.68 per dollar last month but has since rebounded to around 75 per dollar. Also unable to escape the market forces has been the Mexican peso, which fell to a record low of 19.44 per dollar earlier this month despite attempts by Mexico’s central bank to shore up the currency. The peso strengthened to around 18 per dollar yesterday after the central bank unexpectedly raised its key interest rate to defend the currency.

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