Unhappy New Year to economy from $100 oil

By Alister Bull - Analysis

WASHINGTON (Reuters) - 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.