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G8: All about Oil

Wed, Jun 18 2008, 08:05 GMT
by Yapi Kredi Bank Economic Research Department

Yapi Kredi Bank

Commodity prices have powered ahead of the financial crisis to become the number one priority of international policymakers—this is the single clearest message of this weekend’s G8 statement, which confirms in particular the common emphasis on commodity prices by Trichet and Bernanke two weeks ago. And stagflation is clearly the underlying, unspoken concern—a serious one, because there is no easy cure for it. The G8 Ministers say that policy choices have become “more complicated”. This is an understatement. Standard macroeconomic policy tools are likely to prove powerless against a possible persistent rise in commodity prices. The pressure therefore builds up on oil producers to step up supply and investment (with reports of a possible significant increase by Saudi Arabia) and legislators and regulators to possibly limit financial investment in commodities. If none of this works, a global recession might be the inescapable consequence, and the only way to halt the rise of commodity prices. The statement’s overall tone of concern over price developments (stagflation) with a slightly more sanguine view on growth will probably confirm the recent bearish mood in fixed income markets. Nothing notable on currencies, which might feel like an anti-climax after the dollar run of the last few days and may trigger a correction—tempered however by the potential for oilbearish news from the June 22 oil producers summit.

Last April, the G8 statement was devoted almost entirely to the steps needed to tackle the financial crisis. Saturday’s statement notes that we have seen some improvement in financial markets conditions in the last few months, thanks mostly to some easing of the information crunch and to some progress in recapitalization of banks—although much remains to be done. All the attention and carefully drafted prose that two months ago was devoted to financial markets, this time is devoted to commodities.

“Elevated commodity prices, especially of oil and food, pose a serious challenge to stable growth worldwide, have serious implications for the most vulnerable, and may increase global inflationary pressures. These conditions make our policy choices more complicated.” This key passage in the statement seems to stress the growth risks of commodity prices. However, the last sentence says it all. Policy choices have become more complicated. Rising commodity prices are a serious threat to growth, but one that cannot be countered by looser monetary policy. Central bankers have emphasized ad nauseam in the last few days the need to keep inflation expectations well anchored, and this implies at the very least a hawkish monetary stance.

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Published on  Wed, Jun 18 2008, 08:10 GMT