July 14th, 2008
08:04 AM GMT
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LONDON, England – Could oil hit $200 a barrel by year end?   

Given the sharp rise already, what once seemed fanciful thinking now has to be taken more seriously. After all, oil prices have doubled in the past year. More frightening, if you take the crude oil inflation rate of the past five years (which has seen prices quadruple) prices would rise to $580 by 2013, according to analysis by ING.

We already know the pain being felt at $145 oil - what happens if it jumps to even $200 a barrel by year end?

According to ING, U.S. inflation would hit 7 percent. The impact on Europe would be more muted with inflation around 4.5 percent. That rise in inflation would prompt the U.S. Federal Reserve to raise its funds rate from the current level of 2.5 percent to 3.5 percent by year end, and the European Central Bank would raise its rate from 4.25 percent to 4.75 percent.

"In turn this would compound the downward pressure on economic growth. The combination of a squeeze on consumers' purchasing power from rising oil prices and higher interest rates would likely lead to a full blown recession in the U.S. with the contraction of output deepening in early 2009. Output in the Eurozone would also be badly hit, although growth might narrowly escape slipping into negative territory.

"This environment would surely intensify the credit crunch. With activity slowing markedly, asset prices would tumble and default rates would climb. On top of this, rising short-term rates would add to the banks' problems by squeezing their margins further. This is clearly a recipe for a vicious cycle in which financial sector woes and real economy weakness feed off one another," ING adds.

ING isn't predicting that oil will hit $200 a barrel by year end, and even it it did, it says it wouldn't be sustainable.

That's because the damage to economic activity would be enough to drive oil demand down sharply and with it prices, plunging back to $100 a barrel by the end of 2009, leading to deflation and a sharp fall in interest rates.

Of course, mainsteam forecasts don't have oil at $200 a barrel by year end. But given how wrong economists have been about the rise in oil prices, neither can we dismiss the possibility. One thing we know for sure, if it happens, it's going to be ugly.

Tell me what you think: Do you think oil can go to $200 a barrel, and what do you think the impact would be. Is there anything policymakers could do to prevent it happening, and whose fault is it if it does reach $200 a barrel? Can you can even imagine oil trading at close to $600 a barrel five years from now? I look forward to hearing your thoughts.  



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