WASHINGTON—Federal Reserve Chairman Ben Bernanke signaled Wednesday that he expects to hold interest rates steady awhile because the economy is poised between the contradictory threats of stubborn inflation and slowing growth.
Bernanke indicated to the Joint Economic Committee of Congress that leaving rates alone should balance those threats.
"To date, the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and a gradual ebbing in core inflation," he said.
That was a clear signal that the benchmark federal funds rate, which influences a broad array of bank lending rates, will remain where it's been since last June, at 5.25 percent.
The central bank chairman also said that a housing slowdown and a rise in defaults on mortgages held by the riskiest borrowers hadn't hurt the broader U.S. economy. He said the broader mortgage market remained healthy, even as the sub-prime market was in turmoil.
Inflation remains "uncomfortably high," Bernanke said, and the recent surge in energy prices threatens to push it higher.
However, he also warned that "uncertainties around the (economic) outlook have increased somewhat in recent weeks." That means the economy may be slowing more than expected, which could push the Fed to cut interest rates to spur growth later in the year.
As his testimony underscored, Bernanke walks a tightrope. He has a dual mandate to promote full employment by keeping the economy growing while keeping inflation low to promote stable prices. Right now those mandates are pulling in opposite directions. The housing slowdown crimps growth and argues for rate cuts, but worrisome inflation erodes purchasing power and argues for rate hikes.
"We're looking for a bit more flexibility, given the uncertainties we are facing and the risks that are occurring on both sides of our outlook," the Fed chairman said in answer to a question.
Wall Street didn't like what it heard.
The Dow Jones Industrial Average fell 130 points right after Bernanke began testifying, but rebounded later in the day. It closed down 96.93 points, or 0.78 percent.
Investors don't like the emerging trend of slower growth and stubborn inflation, because it sounds like ྂs-style stagflation—when economic growth was stagnant yet inflation was persistent.
Investors apparently read into Bernanke's testimony that he's more inclined to raise rates than lower them, even in the face of a slowing economy. Higher rates slow economic growth and thus tend to depress stock prices.
"The Fed cannot afford to get lax on inflation at this time and Bernanke knows it," Dustin Reid, a strategist for ABN Amro in New York, said in a note to investors. "But at the same time, the Fed sees increased uncertainties and wants to leave all options open—hence the standard comment about data dependency going forward."
Wall Street also is fretting over rising oil prices, which rose $1.15 per barrel to $64.08 Wednesday on the New York Mercantile Exchange. The trend is sparked in part by rising tensions in the Persian Gulf after Iran captured 15 British troops last weekend.
Making matters worse, new Commerce Department numbers Wednesday for sales of durable goods—big-ticket machinery and equipment—showed only 2.5 percent growth, slower than expected.
"Durable goods orders declined 9.3 percent in January, so the February bounce-back was far from complete. More importantly, the gains in February's orders were concentrated in defense and aerospace—notoriously volatile sectors," said Daniel Meckstroth, chief economist for the Manufacturers Alliance/MAPI, a trade association. "It is still too early to tell if the equipment-spending slowdown is merely weather-related or a real shift toward risk avoidance by businesses amid the uncertainty surrounding the housing decline and mortgage credit problems."
Reflecting the rising hardships that their constituents face, lawmakers pressed Bernanke for his view of the slumping housing market.
"The near-term prospects for the housing market remain uncertain," the Fed chairman said. He added that even if demand for housing falls no further, "weakness in residential construction is likely to remain a drag on economic growth for a time, as home builders try to reduce their inventories of unsold homes to more normal levels."
He acknowledged that the recent climb in defaults by holders of sub-prime variable-rate loans, the riskiest kind, has sparked concern that defaults might spread to the broader mortgage market. However, there's no evidence of that, he said.
Sub-prime loans make up less than 10 percent of outstanding mortgages, so there's a limit to the potential spillover. But many of the defaults are in high-priced markets such as New York, Florida and California, and foreclosures add to the number of unsold homes in those markets, depressing prices.
A few months ago, there was widespread belief that the worst was over for the important housing sector. Now analysts and even the Fed chairman aren't quite sure when and where that market trend will bottom out.
Commerce Department data released Monday show that sales of new single-family homes slumped 3.9 percent in February, the slowest pace in nearly seven years. Those dismal numbers were on top of the 15.8 percent plunge in January, which represented the largest one-month decline in 13 years. Prices also were down slightly in February from a year earlier.
(c) 2007, McClatchy-Tribune Information Services.
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