Oil prices have dropped sharply as traders bet that a pause in US attacks on Iran could prevent an escalation in the conflict that would further restrict global supply.
Brent crude, the international benchmark for oil, fell 9% to below $88 a barrel on Monday morning, after climbing to $100 last week when the Iran-aligned Houthis attacked Saudi Arabian oil tankers in the Red Sea.
Oil prices retreated from the short-lived return to more than $100 a barrel as the US and Iran paused hostilities after 13 days of fighting, amid tentative signs that talks to end the conflict may have resumed.
Iran said it had stopped “retaliatory” attacks after two nights without American missiles, after the US ambassador to the UN, Mike Waltz, told journalists on Sunday that Donald Trump had decided to pause the attacks to allow more time for diplomacy. Separate reports claimed that US military officials had warned Trump that the bombing campaign had reached the limits of its effectiveness.
The comments raised hopes that a renewed focus on diplomatic solutions could de-escalate the regional conflict, which since the end of February has disrupted flows of oil and gas from Gulf nations via the strait of Hormuz, and in recent weeks has interrupted vessels leaving the Red Sea via the Bab al-Mandab strait, too.
However, the brief reprieve from rising oil prices was met with scepticism by some market observers. “We’ve been here multiple times since March,” said Ole Hvalbye, an analyst at SEB Research. “And each rally on a leak has faded as substance failed to materialise. ”
John Evans, an analyst at PVM, said he expected that oil prices would only be able to fall further if there was a meaningful fall in demand, “not questionable mini-ceasefires”.
He said: “The market seems to be forever seeking good news from an arena that really is not providing any. A stay of military strikes might seem an improvement, but it does not come with any guarantees that oil will soon flow from the area.”
Analysts at Deutsche Bank led by Jim Reid said that the 10% increase in Brent crude prices last week had “added to fears that the global economy was facing a prolonged inflation shock, and that the Fed might need to hike rates more aggressively in response”.
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The expectation of higher inflation caused by rising global energy costs has put pressure on central banks to raise interest rates. In recent weeks that has pushed up sovereign bond yields, which move inversely to prices. However, the oil price drop on Monday prompted yields to fall. The yield on UK 10-year government debt dropped below 5%, down 0.05 percentage points during the day. The rate-sensitive two-year yield fell 0.06 percentage points to 4.35%.
Higher oil prices could harm Trump politically, with many members of the Republican party nervous of the effects of inflation on their prospects at midterm elections in November. Some Federal Reserve policymakers may feel the need to raise interest rates to try to counteract price increases, a move that could slow the US economy – despite Trump’s wish for lower rates.
