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Oil, interest rates a 1-2 punch?
Current oil price hike may hit economy harder than '04 spike as rates also climb this time.
March 10, 2005: 2:30 PM EST
By Chris Isidore, CNN/Money senior writer

NEW YORK (CNN/Money) - The U.S. economy rode out $55 a barrel oil last fall. But some economists say that the latest spike in that key commodity poses a greater threat to the nation's economic growth.

Those economists say that the combination of rising oil and rising interest rates constitute a one-two punch for the economy that will be much harder over overcome.

Last September and October, as oil shot up more than 25 percent to $55 a barrel in less than two months, interest rates fell. The yield on the 10-year treasury bond declined 6 percent in that period.

With that low rate environment, the nation's gross domestic product grew at 4.0 percent annual pace in the third quarter and 3.8 percent in the fourth quarter, even in the face of rising oil prices and imports. That was better than the 3.3 percent growth rate seen in the second quarter.

But the current spike in oil prices has come at a time when the 10-year yield is rising up 12 percent in the last month while oil prices climbed 21 percent.

"I don't necessarily think it'll be a knockout punch, but it'll deliver a blow to economic growth in 2005," said Rich Yamarone, director of economic research at Argus Research.

These warning signs come at a time when there are a number of new economic projections showing an improving outlook for growth in 2005. And some economists still believe the economy is resilient enough to grow faster, even in the face of the oil and interest rate pressures.

"Growth is more likely to firm modestly from here and it's quite unlikely to ease much further," said Anirvan Banerji, director of research for the Economic Cycle Research Institute. He said 5 percent GDP growth might be out of reach but he would expect better growth than at the end 2004.

But other economists say that the combination of the oil and interest rate hikes pose a serious threat that has brought about recessions in the past.

"When we are going at 4 percent, it's difficult to fall all the way back to contraction. But we could definitely end up having slower growth," said Ohio Northern University professor A. F. Alhajji, an expert in energy economics.

Alhajji said that oil prices do have less impact on the overall economy than they did in the late 1970s and early 1980s, during previous price spikes, because of the growth of service and technology sectors, which consume less energy than traditional manufacturing. But he said that the rise in oil and interest rates in 2000 was a major factor in the 2001 recession, proving the economy can't just shrug off high energy prices.

Dean Baker, co-director of the Center for Economic Policy Research, said that the disconnect between oil prices and interest rates seen for much of 2004 is an aberration. The rule in economic history he said is that rising oil prices raise inflationary concerns and feed higher interest rates.

Yamarone and some of the economists expressing concern point out that one period when both interest rates and oil prices were rising was in the spring of 2004, a period that preceded the so-called "soft patch" during which economic growth continued but at rates less than forecast. Yamarone said it's possible a new soft patch is already beginning.

"If you look at economic data we've received since the beginning of the year, it's been definitively lower than consensus expectations in most cases," he said.

Baker estimates that he would expect if interest rates and oil prices rise modestly from this point, that economic growth will slow to about a 2.5 percent annual growth rate later this year. But he said that if there is a sharp spike in oil prices or higher interest rates, it could bring about an actual recession, especially if the higher interest rates lead to a fall in home values.  Top of page


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