How do oil prices affect currency prices?

I used to think that oil prices affected most currencies equally and
before getting into forex, I never would have thought about this. 
But now that I do trade, I think finding the answer to this question is
important.  I have summarized an interview with a Chief Strategist
that tries to answer this question.  Read more to find out which
currencies are hurt and which may benefit from rising oil prices.

First we will look at a framework on how to determine how higher oil prices will impact certain currencies:

1) Look at how dependent a particular country is on oil   

• A country’s dependency is very important in determining how its currency will be impacted by a change in oil prices.
• Intensive energy users (or net oil importers) will be more
  negatively impacted than other countries. Falling oil prices benefit
  consumers in the same way as tax cut, while higher oil prices act like
  a tax hike.
• For corporations, higher oil prices can translate into lower
  profits. Countries with alternative fuel sources, and other resources
  have the ability to switch from strict oil dependence to other energy
  sources, which helps to reduce their exposure and sensitivity.

2) Monetary Policy Responses

• How reactive a country’s monetary policy authorities are to
  rising inflation is also very important in forecasting a currency’s
  reaction.
• Countries with inflation targets may be more aggressive at
  combating inflation and will adjust their monetary policies
  accordingly, while others who may be dealing with low inflation will
  keep monetary policy accommodative to guard against slower growth as a
  result of higher oil prices.
• Monetary policy and interest rates are key drivers of currency movements.

3) Does the economy have a large oil-related market cap vs. industrial market cap

• Market cap composition may also influence how the oil price affects a currency via capital flows.
• The currencies of countries with a low energy-related market cap,
  but a high industrial market cap is more likely to be hurt by higher
  oil prices.
• Investment flows may be muted by the decreased profitability of these types of industries.
• Countries with heavy manufacturing and high levels of oil imports will most likely have the most exposure.
• As you see, the key factors to look at are GROWTH and INFLATION
• However, inflation isn’t only driven by high oil prices. In the
  US, higher prices for everything from chemicals and food to industrial
  commodities and labor are hitting the US economy hard. As the US
  economy sputters trying to gain momentum, employers are faced with more
  and more obstacles.
• So with the threat of inflation looming it’s important to consider the monetary policy reactions of the global central banks.

A) Which Currencies Will Most Likely Be Negatively Impacted By Higher Oil Prices?

•  In my opinion, its the US dollar and Japanese yen

         Lets look at our framework to determine why

1. Dependency on oil
   • The US and Japan are the world’s two largest net oil importers.
   • Skyrocketing oil prices will have a particularly damaging
     effect on the economic recoveries in both countries by effectively
     threatening to stall growth.
   • Fed Chairman Alan Greenspan has already warned that rising
     oil and gas prices could have a significant impact on the long-term
     development of the US economy.
   • In the case of Japan, their lack of domestic sources of
     energy and their need to import vast amounts of crude oil, natural gas,
     and other energy resources makes them particularly sensitive to changes
     in oil prices.
   • Japan also lacks the flexibility to switch to nuclear power
     because they are a huge net importer of uranium for their nuclear power
     plants.

2. Monetary Policy
   • Aside from their high reliance on external oil, the Federal
     Reserve and the Bank of Japan are also more likely to focus on growth
     rather than inflation.
   • Both countries have been grappling with very low levels on inflation and even what may be considered deflationary conditions.

 B) Which Currencies Will Most Likely Benefit From Higher Oil Prices?

• In my opinion – The British Pound and the Euro

1.  Dependency on oil
   • The United Kingdom is a net oil exporter and stands to
     benefit from rising oil prices. Although their oil exports are
     relatively small, they are not subject to the same net ramifications as
     oil importers such as the US or Japan.
   • On the other hand, Germany and France, the two largest countries in the Eurozone are net oil importers.
   • Germany’s crude oil imports, especially from Iran have been
     climbing drastically since the year 2000. Another Eurozone country that
     may suffer from higher oil prices is Italy.
   • Almost 60% of Italy’s energy comes from oil, most of which is imported. Gas accounts for another 30% of energy use.
2. monetary policy
   • More importantly though are the forecasted monetary policy reactions of the Bank of England and the European central bank.
   • Both monetary policy authorities are particularly concerned with rising inflation.

And most importantly which currency pairs that will benefit the most?

1. GBP/JPY
2. EUR/JPY
3. EUR/USD
4. GBP/USD

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