The relationship between the Brent crude oil price and the dollar exchange rat
A strengthening of the inverse relationship between the price of Brent crude oil, which is traded in US dollars, and the dollar exchange rate has been evident since 2002, with the gradually rising price of oil having been accompanied by depreciation of the dollar. This trend peaked in 2008, when the effective exchange rate of the dollar weakened to a historical low in March (close to USD 1.6 to the euro) and the average monthly price of Brent oil then reached an all-time high of USD 134 a barrel in July. A similar situation has been observed in recent months, when oil price growth has been accelerating again amid a weakening of the US dollar.
Brent crude oil price and USD exchange rate
An inverse relationship between the price of Brent crude oil and the dollar exchange rate has been evident since 2002
(source: Datastream and IMF – International Financial Statistics)
This box examines the interdependence between the monthly returns of the two variables. As Chart 2 shows, the negative relationship between the dollar and the Brent oil price has increased over the last few years. The average coefficient of correlation between the two returns since 2007 is -0.6.
Correlation between Brent crude oil and USD exchange rate
The average correlation coefficient since 2007 has been -0.6
(source: Datastream and IMF – International Financial Statistics, CNB calculation)
A similar inverse relationship with the dollar exchange rate is visible for other commodities, such as industrial metals and agricultural commodities. One explanation for this inverse relationship is the growing role of investors in commodity markets, related to falling financial asset returns (low interest rates) in advanced countries. Three-month rates on the dollar money market have averaged only 2% since 2002, compared to 6% in 1982–2001. In real terms, interest rates were 2.6% on average in 1982–2001 and have declined to an average of -0.4% since 2002. In addition, the Fed commenced a first round of quantitative easing (QE1) at the start of 2009. This was replaced with a second round (QE2) between November 2010 and June 2011. Under QE1, the Fed supplied the financial system with additional liquidity of USD 1.7 trillion, and USD 600 billion is planned for QE2. In this situation, oil and other commodities are alternative investment assets used to diversify the risk of inflation, the risk of dollar depreciation or the risk of a stock market decline. Above and beyond traditional fundamental factors, additional speculative demand has therefore probably been driving up commodity prices in recent years.
Using a simple regression equation including other relevant factors underlying Brent oil price movements (e.g. industrial production growth in OECD countries, real interest rates, oil inventories and the rate of use of oil refineries in the USA), we estimate that since 2005 a weakening of the effective exchange rate of the dollar of 1% has, on average, been accompanied by a rise in the Brent oil price of 2.1%.
The negative relationship between the Brent crude oil price and the dollar exchange rate has thus dampened the impact of sharp fluctuations in the dollar price of Brent oil in “non-dollar” economies, including the Czech Republic. As the Czech koruna usually moves similarly against the dollar as against the euro, the impacts of fluctuations in dollar prices of oil on the Czech economy have been dampened similarly as in the euro area countries. Moreover, the dampening effect on the Czech Republic has been increased by the long-running nominal appreciation of the koruna against the euro (the average annual appreciation of the koruna against the euro since 2002 has been 3.1%).
Growth in the koruna price of oil relative to the dollar price of oil was dampened most of all between September 2007 and September 2008, when the difference in annual growth between the dollar and koruna price of Brent oil was 32 percentage points. In the first three months of this year the difference was 7 percentage points.
Brent crude oil price in CZK
The average difference in annual growth between the dollar and koruna price of oil between September 2007 and September 2008 was 32 percentage points
(annual percentage changes; percentage points; source: Datastream, CNB calculation)