THE surge in oil prices to a record level of more than $139 a barrel on Friday has left the economy facing a severe “stagflationary” shock, economists say, with a rising risk of recession alongside high inflation.

A record, two-day surge in oil prices of $16 a barrel last week followed analysts’ predictions that the price will soon hit $150 and could go as high as $200. While others say that the sharply rising price is indicative of a speculative bubble that will soon burst, few investors have so far been prepared to bet against it.

Sushil Wadhwani, a former member of the Bank of England’s monetary policy committee who now runs Wadhwani Asset Management, said he was very gloomy about the economic outlook.

“We have the classic problem of a stagflationary shock,” he said. “We have a slowing economy, the European Central Bank telling us it is going to put interest rates up and now this. The world has become a very unfavourable place. Muddling through this is going to become very difficult.”

David Kern, economic adviser to the British Chambers of Commerce, said: “The global economy is going to look a lot less robust and the oil-price rise is very bad for business in two ways. It has a direct effect on firms through rising costs and it removes from the agenda the possibility of the Bank cutting interest rates.”

Part of the oil price’s surge was driven last week by weakness in the dollar, which slumped after figures showed US unemployment rising from 5% to 5.5% last month, increasing fears of inflation. There could be a new stimulus package in the final months of the Bush presidency. “Don’t rule it out,” said White House counsellor Ed Gillespie.

Energy ministers from the Group of Eight industrial nations, meeting in Japan yesterday, called on oil producers to increase output to reverse the sharp rise in prices. They also committed themselves to increased investment in energy efficiency and alternative technologies.

A separate meeting of the five top energy-consuming nations, America, Japan, China, India and South Korea, revealed splits. Sam Bodman, the US energy secretary, called for a removal of energy subsidies to limit demand growth. India removed some subsidies last week.

However, China blamed speculative “hot money” for the rise in prices and said there was a limit to how quickly subsidies could be removed.

China’s central bank yesterday announced measures designed to rein in inflation, raising the amount the country’s banks must hold in reserve by a full percentage point. The reserve requirement ratio, which is to be lifted in two stages to 17.5% on June 15 and 25, is the fifth increase this year but the first time since December the central bank has opted for more than a half percentage point rise.

The alarm bells are ringing this weekend in sectors directly exposed to the oil surge.

Ryanair boss Michael O’Leary said he expected several European airlines to go out of business thanks to high oil prices.The industry would restructure into a handful of strong players, he said. O’Leary predicts that just three European “network” airlines - British Airways, Lufthansa and Air France/KLM - will survive, and one low-cost airline, Ryanair. Budget rival Easyjet would be bought by one of the big three, he said.

Ryanair, which last week reported after-tax profits of €401m (£327m) for the financial year just ended, may only break even this year.

Meanwhile, haulage groups, which are already under pressure from high oil prices, are urging the government to stop new European rules that allow foreign haulage firms to compete for UK work. The move will be discussed by EU transport ministers on Friday.

Under the new rules, foreign lorry drivers who pay much less for fuel, because of different tax rates, will be able to do three jobs a week in Britain from 2011, and will be free to compete openly from 2014. Hauliers in the UK pay 50.35p in tax per litre of diesel, compared with a continental average of 25p. “It would be hard to blame a haulage manager at a big supermarket group, for example, who tried to take advantage of that cost difference,” said the Freight Transport Association.

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