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Fed policy to blame for surging commodity prices, says New Star’s Ward

Federal Reserve policy is to blame for the surge in commodity prices rather than market speculators, New Star economist and strategist Simon Ward has argued.

New Star warns that oil prices at $140 a barrel threaten to abort the expected second-half recovery in US growth.

Ward says that expectations for official interest rates later in 2008 are lowering with some economists are even talking of cuts, but he believes it is the Fed’s policy of cutting interest rates that is the prime cause of the current economic problems.

New Star analysis of the Goldman Sachs’ commodity price index reveals that it stabilised from mid-2006 as the Fed moved its target funds rate above 5 per cent and the explosion upwards only started when the Fed went into reverse and cut rates aggressively from last autumn.

Prices have risen by over 60 per cent in less than nine months, which is the equivalent to the gain over the prior three years.

New Star believes that commodity prices – particularly energy – may now be above the level needed to equate demand and supply over the medium term.

Ward says: “Markets that overshoot fundamentals sometimes fall back to earth just under the weight of their overvaluation.

“More usually, a tightening of monetary conditions is necessary to trigger the adjustment.”

He cites the example of the technology media and telecoms bubble of the late 1990s, which burst only after the Fed raised official rates from 4.75 per cent to 6.5 per cent.

Ward adds: “The Fed has damaged the economy by buckling to the demands of Wall Street interest rate doves.

“A commitment to a stable dollar, backed up if necessary by policy tightening, would be the best route to a recovery. More of the same is a recipe for continuing woes.”

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