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Bernanke appears poised to pause
SHAWN McCARTHY
Sunday, August 06, 2006
New York — After 17 consecutive interest rate increases, U.S. Federal Reserve Board chairman Ben Bernanke is widely expected to stand pat when he joins his colleagues at the Fed's regular policy meeting Tuesday.
But the consensus among economists breaks down over where the Fed will steer rates in the coming months, as the U.S. economy shows some signs of slowing but energy-fuelled inflation remains stubbornly high.
A weaker-than-expected employment report on Friday underpinned the markets' expectation that the Fed would hold its closely watched overnight lending rate at 5.25 per cent.
UBS Securities economist Maury Harris said the Fed policy makers have likely completed the cycle of interest rate increases, though he believes the statement released Tuesday will not say so.
“We expect the Fed to be on hold for the rest of the year and start easing in early 2007,” Mr. Harris said in a research report.
For the past two years, the U.S. central bank has raised rates by a quarter percentage point 17 times, after driving them down to a low of 1 per cent to battle deflationary pressures.
The record low rates fuelled a boom in housing and consumer spending that powered not only the U.S. economy but global growth. Now those sectors are showing signs of weakness.
After the Labour Department reported on Friday that the U.S. economy added only 113,000 jobs in July, many economists who had expected at least one more rate hike changed their predictions for Fed action Tuesday. UBS Securities, Morgan Stanley, RBS Greenwich Capital, HSBC Securities, and Barclays Capital all changed their forecasts to a pause rather than another quarter-point increase, Bloomberg News reported. Goldman Sachs Group Inc. and Deutsche Bank Securities maintained their forecasts for an increase.
Mr. Harris said the Fed chairman will likely continue to drive home the need for vigilance against inflation in order to dampen inflationary expectations and calm markets.
“We expect they will at least indirectly continue to convey a bias for more tightening by continuing to stress upside risks on inflation more than downside risks on growth,” he said.
“They could also say that the decision not to raise rates at this meeting will allow more time to assess trends for growth and inflation — consistent with no action at one meeting not necessarily marking the end of a tightening cycle.”
Mr. Harris added that, if the economy continues to show signs of weakness, markets will begin to anticipate a drop in interest rates by the end of the year.
However, Mr. Bernanke faces a growing conundrum as buoyant energy prices threaten to fuel inflation in broader consumer prices and wages. The increase in U.S. consumer prices excluding food and energy reached a near four-year high of 2.4 per cent in June.
Further stoking fears of rising costs is July's wage inflation figure reported on Friday — 3.8 per cent over the past year.
Nariman Behravesh, chief economist with Global Insight, said he expects the Fed not to raise rates Tuesday, but he said Mr. Bernanke will send a strong signal that he remains vigilant against inflation.
“What they're going to face is a number of months where inflation will get worse,” Mr. Behravesh said. “Just simply from a credibility perspective, they're going to have a tough time doing nothing.”
He said business surveys show companies intend to raise prices in response to higher fuel costs and have the pricing power to do so.
The U.S. Commerce Department is expected Tuesday to release data showing a significant upward revision in wage costs.
David Rosenberg, an economist with Merrill Lynch & Co., said he sees no reason for the Fed to raise rates any further, that the current round of tightening has only begun to bite on the housing market and consumer spending.
Mr. Rosenberg noted that Mr. Bernanke has said recently that the economy is in transition to slower growth, to rates that will be below the economy's long-term potential.
He said monetary policy takes several months to affect inflation and inflationary expectations.
Inflation is a lagging indicator of the direction of the economy, he said, noting that in nine recessions after the Second World War, inflation continued to rise through the early months of the slowdown.
Mr. Rosenberg, one of the most pessimistic prognosticators on Wall Street, said he expects GDP growth to slow to 2 per cent next year. “And you know what? I think I'm too high,” he said.
© The Globe and Mail
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