Unhappy New Year to economy from $100 oil

The U.S. economy needs $100 oil like a hole in the head.

The spike in oil to a fresh record on Wednesday is not single-handedly going to tip the United States into a recession. But on top of a housing slump and lingering credit crisis, it increases the head winds facing the battered U.S. consumer.

It also risks higher inflation, which will worry the Federal Reserve and may limit the U.S. central bank's appetite for steep interest rate cuts in the future. Investors are counting on the Fed to shield the economy from a more severe hit.

The oil price increases of the last few years have not caused the major dislocations that we observed in earlier oil price shocks, in part because American consumers seem to be largely ignoring the price of gasoline, said James Hamilton, economics professor at the University of California San Diego.

But consumers also seem to be ignoring the recent softness in incomes, declines in real estate prices, and worries about near-term economic prospects. We may have reached a point where something's going to give, he said.

Economists have long been watching for this breaking point. So far, Americans have kept spending despite a housing slump and a credit crisis that is making banks nervous to lend.

Oil touched $100 a barrel on Wednesday after supply concerns and a weaker U.S. dollar triggered speculative buying, but it retraced part of its run-up before New York markets closed. It settled up $3.64 at $99.62 a barrel.

GRADUAL SQUEEZE

Energy prices have been on a long-term rising track that U.S. consumers have largely brushed off, but the latest run-up gives the screw another turn.

While retail sales were surprisingly strong in November, they were inflated by the rising price of gasoline, and more recent signals from the consumer have been weaker.

There is no magic number (for oil) that makes the economy go into recession ... but this relentless upward movement is gradually squeezing people's spending power, said Nigel Gault of economic forecasting firm Global Insight.

It will give gasoline and heating oil prices another upward nudge, which matter much more to consumers than the price of a commodity traded on a distant financial market.

Against a backdrop of lackluster jobs growth and falling house prices, the latest spike in the cost of oil deepens the risk economic growth will fall short of already low expectations.

If we see people losing their jobs, housing getting worse and energy prices staying high, the combination of these three things could change the economic outlook. But any one alone is probably not enough to do it, said Adam Sieminski, chief energy economist at Deutsche Bank in Washington.

The U.S. economy expanded at a robust 4.9 percent annual rate in the third quarter of last year, but growth appears to have slowed sharply in the final quarter and is expected to remain sluggish in the opening three months of 2008.

The Fed has cut interest rates by a cumulative 1 percentage point since mid-September and investors bet it will seek to help the economy further by lowering interest rates by another quarter-point, to 4 percent, at its next meeting on January 29-30.

But high oil prices have helped pushed the consumer price index to a 4.3 percent gain over the 12 months through November, and some Fed policy-makers have recently warned that rising food and energy prices should not be ignored.

We expect it will remain above the 3 percent level, which is really too high for the Fed and too high for households to feel comfortable. It bites into purchasing power. This is a big drag on real income and real spending, said Harm Bandholz, economist with UniCredit in New York.

Fed Chairman Ben Bernanke tackled oil and the economy in a speech in October 2004 while a governor on the Fed board.

He said policy-makers could lower interest rates to buffer the economy from an oil shock only if inflation was low and expectations for future price rises remained contained.

Whether monetary policy eases or tightens following an increase in energy prices ultimately depends on how policy-makers balance the risks they perceive to their employment and price-stability objectives, he said.

(Additional reporting by Emily Kaiser in Washington; Editing by Leslie Adler)