Colin Barr

Following the money in banking, economics, and Washington

How a rate hike could mean $4 gas

April 6, 2011: 2:59 PM ET

Are the inflation hawks about to treat us to a round of $4 gasoline?

It's not quite as strange a suggestion as you might think. If traders react to Thursday's expected European Central Bank rate hike the way they did three years ago, oil prices – already trading at highs last seen in mid-2008 -- could be headed for another painful surge.

Summertime blues

With the average U.S. gas price at $3.71 a gallon, any oil spike would deliver another hit to a U.S. recovery that is already laboring under the burden of higher commodity prices and, let's face it, poorer consumers. Brace yourself for more headwinds, Ben Bernanke.

"Central bankers will always claim that they have no influence on oil prices," says Olivier Jakob of Swiss trading firm Petromatrix, "but recent history has repetitively shown that in the new world where commodities are a global asset, central bankers can have a greater influence on oil prices than OPEC."

The ECB is expected to raise interest rates Thursday morning, marking the first time since the financial crisis that a major rich-country central bank has done so.

Raising rates looks like the responsible course at a time when everyone is fretting over rising food and fuel prices. ECB chief Jean-Claude Trichet has impeccable credentials, having gone forward with a 2008 rate hike even as the global financial system teetered on the brink of collapse. Trichet warned last month that the ECB would have to be vigilant against rising inflation.

But it's worth noting what happened the last time Trichet went down this road. In June 2008, he surprised markets by announcing plans to boost the ECB's main lending rate to 4.25% from 4%.

The move came at a time when the Fed was already cutting U.S. rates, weakening the dollar. The ECB move sent funds surging into both the euro, as the major currency offering the best interest rates, and into oil, as a commodity hedge against dollar weakness.

The result was a one-day, $16 surge in the price of Brent oil futures in London, to $138 a barrel, on the way to a ruinous $147 the next month (not to mention an equally stunning post-bust $30 in December 2008).

A rise to $138 now could translate to $118 or so for the West Texas Intermediate futures traded in New York – a level Jakob says could well mean $4 gas.

Of course, there are reasons to doubt we'll see an oil spike. The ECB's move this time around is widely anticipated, and the euro zone is more obviously on the verge of severe financial trouble of its own this time round, what with Portuguese interest rates at 10% and European banks rushing to raise new capital. Some observers believe oil prices are due to fall as fears of Mideast unrest subside.

But if we do see a spike there's little doubt that the U.S. economy is in a less than ideal position to deal with them.

The average U.S. gasoline price is $3.71 a gallon, AAA reports, which Jakob of Petromatrix notes is the highest price ever heading into the summer driving season.

What's more, the food stamp rolls have expanded by 16 million people since our last brush with $4 gas, in the summer of 2008, while the ranks of the unemployed have risen by 5 million.

If prices do march higher, we surely will start to hear calls for the politicians to do something -- not that the guys who brought you the ethanol mandate are likely to help matters. It's early yet, but maybe there is a bright side to a government shutdown after all.

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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