Cheaper oil may see euro, yen fall

Falling oil prices might well prove negative for the euro and the yen if the foreign exchange market concludes cheap crude will undermine efforts to fend off deflation in the euro zone and Japan. With one facing deflation and one seeking to boost inflation, they might ordinarily be expected to welcome a lower oil price, which would lessen costs of production and increase economic activity.
But the consequence could be energy price-led disinflation. Both the euro zone and Japan might seek to offset falling oil prices through policy measures that could result in weaker local currencies. Brent crude fell to just above $88 a barrel on Tuesday. Saudi Arabia earlier this week privately informed oil market players it can tolerate prices between $80 and $90 for an extended period.
This may make life uncomfortable for high-cost energy exporters, less able to compete with major Middle East producers, who may also find their currencies depreciate as investors calculate their prospects are less bright. A perception that the cost of extracting Western Canada Select, the heavy crude in Canada's oil sands, might be uneconomic if the global crude price falls further could hurt the Canadian dollar even if local producers would argue otherwise.
It is potentially bad news too for Norway's crown as the oil and energy ministry has warned that costs will be higher than expected in several projects in the oil and gas sector, already one of the most expensive in the world. The same logic could also be applied to the Russian rouble adding to its woes derived from Ukraine-related sanctions. Russia has balanced its 2014 budget at $114 a barrel.
Russian discomfiture with a lower oil price might arguably suit Saudi Arabia, which has not seen eye to eye with Moscow over its backing for Syrian President Bashar al-Assad. The default winner might end up being the dollar. Although lower oil prices might put question marks over the commercial viability of some shale oil projects, much of the production is reserved for domestic consumption, not exports. Further dollar strength might affect when the US Federal Reserve hikes interest rates but not the central bank's direction of travel. It is hard not to conclude that, particularly with the oil price falling, the dollar should end up higher against a number of major currencies, even from its current level.