The crude market has suffered its sharpest single-day rout in 18 months, with Brent crude sliding to $72.40 a barrel, a level not seen since before the Iran escalation. The sell-off accelerated after a surprise inventory build in Cushing, Oklahoma, and renewed chatter of OPEC+ discord.
The UK Treasury, already nursing a fragile gilt market, is now monitoring the knock-on effects on inflation expectations and the consumer wallet. For the Chancellor, this is a double-edged sword. Lower fuel costs should ease the cost-of-living crisis, but the speed of the collapse reeks of a market pricing in a demand shock.
Gilt yields, which had been creeping higher on sticky services inflation, paused their ascent. The 10-year yield settled at 4.12 percent, down 8 basis points.
If oil stays at these levels, the Bank of England may have room to cut rates sooner than the hawks in Threadneedle Street would like. But do not pop the Champagne just yet. This is a market that has learned to distrust every rally.
The last time oil traded at $72, Rishi Sunak was still Chancellor. The question is whether this crash is a cyclical adjustment or the beginning of a deeper rout. Capital flight from oil-exposed currencies has already begun, with the Norwegian krone and Canadian dollar taking hits.
For the pound, the picture is more complex. A weaker oil price reduces input costs for UK manufacturing, but it also signals a global economic slowdown that would hit exports. The Treasury's debt management office will be watching the 30-year gilt auction next week with hawkish eyes.
If the market interprets this oil crash as deflationary, it could spark a rush into long-dated gilts, which would be a welcome relief for the DMO's borrowing programme. But the risk is that it is read as a symptom of a global recession, in which case risk assets will be sold, and the pound will suffer. The bottom line: lower oil is good for the UK's terms of trade, but the manner of its arrival is unsettling.
For now, the Treasury will take the breathing room, but the Chancellor knows that the reprieve may be temporary. The OPEC+ meeting in June now looms large, with Saudi Arabia and Russia seemingly at loggerheads. If the cartel fails to agree on output cuts, we could see a full-blown price war, taking crude to $60.
That would be a game-changer, but not necessarily the positive one the markets are assuming. Deflation is as dangerous as inflation when it strikes in the wrong place.
