Will the Price of Oil Lead Us Into a Recession?

Could persistently high oil prices lead us into a recession? It is hard to tell at this point, but it is not going to help. Text in bold is my emphasis. From Bloomberg:

``We are in a danger zone,'' says Nariman Behravesh, chief economist at Global Insight Inc. and a former Federal Reserve economist. ``It would take two shocks to bring the economy to its knees. We got one shock in the form of the credit crunch. Oil could be that second shock.''

Even before the latest jump in energy costs, economists expected U.S. growth to slow to less than 2 percent in the fourth quarter -- half the third quarter's pace. Andrew Cates, an economist at UBS AG in London, said his models suggest a 45 percent chance of a U.S. recession next year, up from 33 percent last month, as oil prices prove a ``growing concern.''

Japan risks its fourth recession since the early 1990s, with its index of leading economic indicators falling to zero for the first time in a decade. The European Commission last week cut its 2008 growth forecast for the 13 nations that share the euro to 2.2 percent from 2.5 percent, partly because of costlier crude. The economy grew 2.8 percent last year.

The world economy may still dodge recession as emerging markets continue to expand. A report last week by Deutsche Bank AG said gains in energy efficiency mean the effect of more expensive oil will ``remain muted.''

Even so, gloom is spreading at a speed that suggests ``we're walking a really fine line,'' says John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina. ``Even a month ago, you probably wouldn't have thought we'd be seeing a sustained credit problem and oil holding up above $85 a barrel.''

The dilemma for central banks is how to balance oil's drag on their economies against the risk of higher inflation. Fed Chairman Ben S. Bernanke told Congress Nov. 8 that oil prices threaten both ``renewed upward pressure'' on inflation and ``further restraint on growth.''

Such concerns prompted the European Central Bank to keep interest rates on hold last week, and President Jean-Claude Trichet said he still sees a danger that inflation will accelerate.

Manufacturers are among the first to feel the pinch: Rising energy prices are increasing their costs while drooping consumer and business confidence erodes demand.

In the U.S., the Institute for Supply Management's manufacturing index fell to a seven-month low in October as gauges of orders and production declined.

Meanwhile, U.S. shoppers, who helped propel most of the current expansion, may cut back as gasoline and home-heating costs rise. Retail-sales growth from November through January may be the slowest since 2002, consultant Ernst & Young estimates. Consumer spending accounts for more than two-thirds of the U.S. economy.

An index of manufacturing growth in Europe dropped to the lowest level in more than two years in October, and confidence among executives in Germany fell to a 20-month low.

Morgan Stanley's model of activity in the euro zone is now flashing the ``risk of manufacturing recession,'' according to Chief European Economist Eric Chaney, a former official at the French ministry of finance. He says the area's economy may run close to its ``stall speed'' of about 1 percent in the first quarter, and ``oil is not making things easier.''

``The stage is set for a significant slowdown in global manufacturing,'' says Joseph Lupton, a former Fed economist now at JPMorgan Chase & Co., which predicts industrial-production growth worldwide will decelerate by more than half before the end of this year, to about 3 percent.