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WORLD BONDS

Short-term gains from lower oil prices

LONDON: An expected rise in oil output next week will prove positive for major bond markets in the short term but analysts were doubtful the oil price reversal would be sustained long enough to affect long-term inflation.

Speculation that OPEC will raise oil production caused crude prices to tumble five percent on Monday, with U.S. benchmark futures falling below $30 a barrel for the first time this month.

This fuelled a rally in bond markets on Tuesday, with benchmark yields falling on both sides of the Atlantic.

"It's too early to suggest that this is a positive factor in the medium term but in the short term it's very helpful," said David Coleman, chief economist at CIBC World Markets in London.

"But we still don't have a lot of the details about how much of an output hike we'll see and therefore how deep and how sustainable the oil price decline will be."

The Organisation of Petroleum Exporting Countries (OPEC) is under pressure from consuming nations to hike output to replenish depleted stocks when pledged production curbs expire at the end of the month. OPEC will meet in Vienna on March 27.

Markets will be watching developments closely since much of the rise in headline inflation over the past months has been attributed to rising oil prices, analysts said. They said that had been largely responsible for keeping bonds in a bear market.

Oil prices have more than doubled in the last year, surging to nine-year highs above $30 a barrel at the beginning of this month. They set a low of $10.25 in December 1998.

Adrian Schmidt, international economist at Chase in London, said, broadly speaking, a $10 oil price rise adds slightly more than 0.5 percent to inflation in Europe and the United States.

NYMEX April crude futures CLJ0 plunged five percent on Monday to end at $29.43 in anticipation that oil producers would loosen their taps within weeks. Benchmark Brent crude futures LCOK0 also dropped sharply, settling $1.35 per barrel lower at $25.21, their lowest in nine weeks.

"We'll get dramatically good inflation numbers in April because this year's decline (in oil prices) will be in while last year's increase will be out and that's got to be positive in the short run," said Schmidt, adding it would benefit short-dated bonds especially.

Analysts said longer term the benefit for bonds of an oil price fall depended on how it fed into the cost of other goods.

"The question is how much of an impact a $5 drop has on second round effects. I think it's quite small," said Schmidt.

CIBC's Coleman said a prolonged fall in the oil price would benefit bonds in the long run because it would take the pressure off central banks from aggressively hiking interest rates.

Adam Beaudin, international bond market strategist with Credit Suisse First Boston in Zurich, said bonds had already rallied significantly in the past week and that oil prices had to fall more to boost bonds further.

"The bond market has not reacted hugely to the news so far and that also goes to show that the market had priced in the likelihood of oil prices coming down from the recent rally."

Beaudin cautioned an oil price fall could be a potential positive catalyst for equity markets which could hurt bonds.

"Though bonds could greet lower oil prices in a friendly way that could quickly be offset by optimism in equities deriving from a Fed who's less inclined to raise rates."-Reuters