Are oil prices and interest rates correlated?

By Ken Clark AAA
A:

Yes. No. Maybe. Definitely.

There's no easy answer to this question. While many theories abound, the reality is that oil prices and interest rates have some correlation between their movements, but are not correlated exclusively. In truth, many factors affect the direction of both interest rates and oil prices. Sometimes those factors are related, sometimes they affect each other, and sometimes there's no rhyme or reason to what happens.

One of the basic theories stipulates that increasing interest rates raise consumers' and manufacturers' costs, which, in turn, reduces the amount of time and money people spend driving. Less people on the road translates to less demand for oil, which can cause oil prices to drop. Thus, in this instance, there might be what we'd call an "inverse correlation" where one thing rises and the other drops.

By this same theory, when interest rates drop, consumers and companies are able to borrow and spend money more freely, which drives up demand for oil. The greater the usage of oil, which has OPEC-imposed limits on production amounts, the more consumers bid up the price.

Another inversely correlated theory, which can occur simultaneously with the first, proposes that rising or high interest rates help strengthen the dollar against other countries' currencies. When the dollar is strong, this helps American oil companies to buy more oil with every U.S. dollar spent, ultimately passing the savings on to consumers. Likewise, when the value of the dollar is low against foreign currencies, something that can happen with sinking interest rates, U.S. dollars buy less oil than before. This, of course, can contribute to oil becoming costlier to the U.S., which consumes 25% of the world's oil.

With all that said, factors such as hurricanes, wars, increased efficiency of new cars, lowered OPEC output, and changes in domestic oil production all can have uncorrelated effects on oil prices. Just when you thought oil prices should go up or down opposite of interest rates, they do something entirely different. Even the fear of occurrences such as natural disasters and wars can cause oil prices to spike just when they should be dropping, as seen over the last decade.

For more on this topic, read Forces Behind Interest Rates and Why You Can't Influence Gas Prices.

This question was answered by Ken Clark.

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