High oil prices have the potential to squeeze consumers and crimp global economic growth, but the dollar could still cope better than the euro and the yen, US currency analysts expect.
While expensive oil may eventually slow the US economy and stay the Federal Reserve's hand on rate increases that have helped to boost the dollar, it may hurt Europe and Japan's economies even more.
Record US gasoline and crude oil prices have grabbed attention in currency markets lately. Investment bank Goldman Sachs forecast this week that crude will stay around $60 per barrel for the next five years. However, Merrill Lynch said on Friday that US light crude prices would likely stay around $42 from 2009.
A few months ago, "People were thinking that these significantly higher prices were not going to stay with us. That is starting to shift", said David Solin, a partner at FX Analytics in Essex, Connecticut.
"We are getting to the point where it could start to cause some problems," as US retailers feel the pressure from some lower-income consumers hurt by energy costs, Solin said.
Even so, Japan's extreme reliance on imported crude and the euro zone's sluggish economic growth make both areas - and by extension their currencies - more vulnerable to sustained high energy prices than the dollar, strategists argued.
US gross domestic product is expanding at about 3.5 percent, compared with expectations of around 1.3 percent in the eurozone this year and an annualised 1.1 percent in Japan in the second quarter.
US interest rate differentials and bond yield spreads over those in Japan and the euro zone are already wide enough to boost the US dollar, and have helped the dollar gain some 10 percent against the euro and 8 percent against the yen so far in 2005.
Even if expensive oil slows down the US economy enough to check the Fed's rate hiking cycle in 2005 or early in 2006, rate differentials probably will have widened further in the dollar's favour by then.
Two reports on US inflation this week exceeded economists' forecasts, signalling that price pressures accelerated in July. Surging energy costs drove US producer prices up 1.0 percent - twice as much as expected - while consumer prices rose 0.5 percent, the fastest pace in three months. For now, that reinforces the currency market's view that the Fed will go on raising rates at a gradual clip.
If higher inflation pressures persist, analysts are divided in their view of the economic effects, said Ed Stapleton, head of foreign exchange at Fortis Bank in New York.
The first camp expects the Fed will have to raise rates more steeply than currently expected to contain inflation. The second camp - to which Stapleton belongs - thinks that higher oil prices will eventually act as an alternative to rate hikes and will deflate the economy.
"What the market believes is that high oil prices are actually a deflationary shock," because they will potentially cap US consumer spending over the long term, said Jay Bryson, global economist at Wachovia Corp in Charlotte, N.C.
"For the dollar it is still very much an open question," how high oil will now play out, Bryson added.
In the oil shock of the early 1970s, the greenback essentially moved sideways against the yen and the German mark, because rising oil prices are "a symmetric shock" to the major economies, and may prove to be so again, Bryson said.
Over the medium term, Stapleton reckons elevated energy costs will slow US economic growth, but expects the dollar will fare quite well because US rate differentials over Europe and Japan will help it.
While higher interest rates may help the dollar, this may be offset by the wide US trade deficit that may become an overwhelming weight on the US currency, some analysts argue.
The trade gap of the United States, the world's biggest crude oil importer, widens with the rising cost of imported oil.
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