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Dovish or Hawkish?

Wed, Jul 16 2008, 14:53 GMT
by Yapi Kredi Bank Economic Research Department

UniCredit Group

Bernanke painted a cautious and concerned picture in his Testimony to Congress today, emphasising both persistent downside risks to growth and rising risks to inflation. The statement could sound dovish or hawkish depending on whether one focuses on Bernanke’s assessment of growth or of inflation—but in my view the language on inflation, if anything, was more hawkish. The growth outlook sounded less sanguine than at the last FOMC, and it had to, given the recent decline in equity prices and the concerns about Fannie and Freddie. But Bernanke was markedly more hawkish in his assessment of inflation risks, with an explicit warning of the risk of second round effects. Some of the language invited comparisons with the ECB, but one needs to be careful here: the Fed does not have only “one needle in its compass”, and needs to weigh more carefully growth and inflation risks. Commodity prices played a central role: Bernanke’s baseline view is that fundamentals remain the main driver of oil prices. If he is right, his Testimony must have revealed much weaker US and global growth fundamentals, because oil prices dropped USD9 per barrel as he spoke. At the same time, however, he conceded in a more explicit way than previously that the weaker dollar could have played some role. On balance, I see today’s Testimony as consistent with a December rate hike, provided the growth outlook does not deteriorate significantly.

Commodities occupied a prominent place in the Testimony. Overall. Bernanke supported the view that fundamentals are by far the main driver of oil prices. He noted that the last several years have seen record world growth, concentrated particularly in emerging economies where growth is more energy-intensive and consumption often subsidised. On the supply side, he noted that production has risen only slightly, reflecting inadequate investment and geopolitical volatility. However, he recognized more explicitly than in the past that “…the decline in the foreign exchange value of the dollar has also contributed somewhat to the increase in oil prices”, although he argued that while difficult to quantify, this effect was likely to be of secondary importance. He also noted that some governments had tightened control over oil resources, restraining foreign investment and thereby preventing increases in capacity and production. Overall, the argument was in line with the position taken so far by the US Administration, which has underscored the importance of fundamental factors and pointed to the need that producers step up efforts to increase production in both the short and the long run.

Bernanke also all but dismissed the role of financial speculation in boosting oil prices, noting that if financial speculation were boosting oil prices above the level dictated by supply and demand, one would expect to see a build-up of inventories, whereas inventories have declined over the last year.

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Published on  Wed, Jul 16 2008, 15:00 GMT