Supply concerns and security fears have combined to drive oil prices to record highs.

Unplanned refinery shutdowns in the US have focussed speculative attention on the possibility of tightness in the supply/demand balance.

Meanwhile, a terrorist scare in Saudi Arabia served to further underpin price increases.

Oil prices are likely to retreat from recent peak levels but we still have to contend with the fundamental issue that global growth has proved to be more resilient than envisaged at the beginning of the year. Furthermore, there is mounting evidence from leading economic indicators that activity will be picking up as we go forward. If this scenario holds up, then oil prices are not going to decline much until growth slows down.

While it differs from country to country, the overall sensitivity of global growth to high oil prices has diminished since the seventies and eighties, when expensive oil was a factor in precipitating recessions. Also, it is well to remember that, in real terms, oil was a lot pricier at that time than it is now.

So, by itself, a higher oil price will not sink the global economy, though it will hurt lower-income households, and pinch the profit margins of oil-sensitive firms. Looking at US consumers, there is some offset from better-than-expected employment creation and income growth. At the same time, the latest data show that the personal-saving rate has fallen to zero. In other words, the household sector isn?t putting any money aside, out of current income.

High house prices, low interest rates and dampened macroeconomic fluctuations have led households to reduce the rate at which they save. But the Fed is aiming to cool the hot housing market and this could lead to some deflation of high house prices, even as energy costs impose a bigger ?tax? on disposable income. So it is important that income growth should continue at a robust pace, or that oil prices fall, if consumption is not to slow down substantially.

A number of lead indicators have turned upward in several industrial economies.

Not all of them have done so, and a few are still tentative but, put together, there is sufficient evidence of a potential upturn in activity as we go forward.

In the US, the Institute of Supply Management (ISM) new orders index is rebounding. Previously, orders had slowed down as a result of an inventory build-up. And now the over-accumulation of inventories is being corrected, leading to an increase in new orders.

Also, the Conference Board?s leading index has made an upward turn.

Elsewhere, business conditions indices in Japan, Germany and the euro area are also pointing upward.

The US July employment report was quite strong, with non-farm payrolls rising a solid 207 thousand, accompanied by a net upward revision for the previous two months.

At the same time, the unemployment rate remains at 5%, while the household survey indicates even more job growth than the establishment data which generates the payroll numbers.

So the Fed will keep on tightening in 25 basis-point steps. Financial conditions remain quite simulative and it is likely that the normalised fed-funds rate is going to be north of the 4% year-end consensus estimate.

As for the flatness of the Treasury yield curve, Greenspan does not believe that it necessarily portends hard times around the corner.

He is probably right, because longer-dated maturities are being held down by strong demand from institutional buyers and Asian central banks, and this has actually stimulated growth.

But the potential rebound in global growth has not gone unnoticed in bond markets, where longer-term yields are now on a rising trend.

What we may get in the Treasury yield curve is not just a flattening but also a tendency for an upward shift in the level of the curve.

This also opens up the possibility of episodes of re-steepening.

Stock markets have stumbled lately on account of higher oil prices and fear of rising interest rates; though sentiment is still positive and this could fuel some more upside market moves.

However, we should continue to monitor oil prices and interest rates. Both are symptomatic of faster growth and both have the potential to slow it down.

Of the two, interest rates in the United States are likely to pose a bigger threat to economic growth in 2006 than the price of oil.

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