WASHINGTON—Federal Reserve Chairman Ben Bernanke signaled Wednesday that he's almost finished raising interest rates because economic growth is slowing enough that it soon will take the steam out of inflation.
Wall Street rallied after Bernanke's testimony before the Senate Banking Committee. The Dow Jones industrials closed up 212 points at 11,011, for a 2.05 percent gain, the largest percentage gain since April 16, 2002. The broader Standard & Poor's 500 index jumped 23 points, or 1.9 percent, to 1,260. The tech-heavy Nasdaq Composite index gained nearly 38 points, or 1.8 percent, to 2,082.
Wall Street seemed to be reacting most to Bernanke saying that the slowing economy should take pressure off price inflation. "We think inflation is going to moderate," he said.
But he also hedged that prediction.
"The recent rise in inflation is of concern," he said, repeatedly citing soaring crude oil and commodity prices that "remain a risk to the inflation outlook."
The Bureau of Labor Statistics confirmed that Wednesday, reporting that inflation, as measured by the consumer price index, rose 0.2 percent in June. More importantly, core inflation—stripping out volatile energy and food prices—rose 0.3 percent.
Core inflation is up 2.6 percent over the past 12 months, and 3.6 percent over the past three months. The Fed's comfort zone for inflation is widely thought to be about a 2 percent annual rate or less.
The CPI, sometimes called headline inflation, is up 4.3 percent over the past 12 months. The Fed has raised interest rates 17 straight times over the past 25 months in an effort to keep a lid on inflation by slowing growth, but so far it hasn't worked.
Bernanke took pains to emphasize that Fed policy is guided more by its longer-range expectation than the latest monthly data, and the Fed expects the slowing economy to ease inflation in the months ahead.
"Our read of it is the Fed is either done or nearly done. They see the economy as already having slowed significantly," said Mark Vitner, a senior economist for Wachovia, the big national bank based in Charlotte, N.C.
Bernanke's testimony didn't erase expectations of at least one last quarter-point rate increase when the Fed's policymaking committee meets Aug. 8. That would take the federal funds rate—the benchmark rate for commercial bank lending—to 5.5 percent. Car loans and mortgage rates tend to move in lockstep with the Fed rate.
"It's still the case that given the rise in core inflation, the Fed raises rates in August," said Dean Maki, the chief U.S. economist for Barclays Capital in New York. "The testimony did not change that view."
Economist Jan Hatzius of Goldman, Sachs, the Wall Street investment bank, read Bernanke the same way, saying his testimony and the CPI data mean one more rate increase Aug. 8.
"We view this move as a final `insurance hike' against the risk of higher inflation," Hatzius wrote.
If the Fed does end its 25-month cycle of raising interest rates, it would be good news for everyone who borrows money from banks to finance housing, autos or other major purchases.
Bernanke left the door open for the Fed to raise rates even further if his expectations aren't met, however. The soaring price of crude oil and other commodities is complicating the Fed's judgment by spreading inflationary pressures as businesses pass along their rising costs to their customers.
Bernanke warned that the Fed is conducting monetary policy "in an environment of uncertainty," not least because there's a long lag between when the Fed boosts interest rates and when its effects are visible in the economy.
Yet, on balance, he predicts a slowdown in growth and a moderation in inflation. "The U.S. economy appears to be in a period of transition," he said, explaining that the strong economy of the past three years reflected "above-trend" growth that has now clearly moderated.
"If the data continue to come in consistent with that outlook, then I think the case for them to continue tightening is pretty weak," said Keith Hembre, the chief economist for First American Funds, a mutual fund company based in Minneapolis, Minn.
The Fed must tread carefully because of the slumping housing sector. Commerce Department data released Wednesday showed that housing starts for single-family homes were down 6.5 percent in June, and 13.8 percent from last June. Further rate increases could turn a chill to a freeze.
"In view of the obvious downward momentum in the housing sector, as well as the considerable downside risks that lie ahead, the Federal Reserve should proceed with great caution," David Seiders, the chief economist for the National Association of Home Builders, said in a statement Wednesday.
Bernanke said he expected the U.S. economy to grow this year at an annual rate of 3.25 percent to 3.5 percent. Since first-quarter growth weighed in at a sizzling 5.6 percent, the economy would have to slow to a growth rate of 2.75 percent or less in the final three quarters of 2006 to reach those year-end numbers.
"That's a pretty sharp slowdown from where we've been," said Maki of Barclays Capital, who's skeptical. He predicts that growth will remain above the Fed's expectation and thus necessitate even more rate increases. "We don't see a dampening of inflationary pressures."
(c) 2006, McClatchy-Tribune Information Services.
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