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Bernanke to discuss growth risks
March 27, 2007 / 10:22 PM / 10 years ago

Bernanke to discuss growth risks

By Mark Felsenthal - Analysis

WASHINGTON (Reuters) - U.S. Federal Reserve Chairman Ben Bernanke is likely to tell Congress on Wednesday that while the Fed sees new risks to economic growth, it remains on guard lest inflation tick any higher.

Bernanke, who appears before the congressional Joint Economic Committee at 10:30 a.m. (1430 GMT), will likely be asked why the Fed ditched an explicit reference to the possibility of interest rate increases from a recent policy statement. He will also be pressed on how hard the housing downturn will hit the economy.

The central bank chief is expected to describe an economy that is behaving much as the Fed had said it would in a report to lawmakers in mid-February, when it forecast moderate growth and gradually declining core inflation. But he is likely to admit uncertainties on both sides of the forecast have grown.

“What we expect him to do is to go out and acknowledge some weakness but to say what they have been saying for three months, that their expectation is that growth will firm mid-year and that they think the primary risk still lies with inflation,” said Joseph Brusuelas, chief economist for IDEAglobal in New York.

In recent weeks, the U.S. economy has exhibited greater weakness than most economists had expected.

New orders for big-ticket U.S.-made durable goods fell steeply in January, with orders for nondefense capital goods excluding aircraft -- a proxy for business spending -- off 6 percent, the steepest slide since early 2004.

Reports on housing also point to lingering weakness. New home sales fell unexpectedly in February and a report on Tuesday showed prices for single-family homes in January were down from year-ago levels for the first time in more than a decade.

Adding to concerns about the housing market, rising foreclosures in subprime mortgage markets threaten to provide an additional impediment to recovery.

Financial markets initially saw the Fed’s shift in language at its meeting last week as a sign it was moving closer to cutting rates. Now, many analysts believe the Fed will hold rates steady for a while to make sure inflation dips.

“There’s no clear indication that there’s an impending recession on the way,” said Victor Li, an economics professor at the Villanova University School of Business. “With core inflation at the higher end of the comfort zone, that’s keeping them from cutting or lower rates.”

The Fed said last week that inflation is its “predominant” concern, and noted that unemployment remains low. Bernanke, an advocate of clearer Fed communications, may provide more insight on Wednesday into how policy-makers feel about prices.

Some officials say they would prefer core inflation, as measured by the 12-month change in the so-called core PCE price index, to be between 1 percent and 2 percent. But that measure rose to 2.3 percent in January from December’s 2.2 percent.

But a speech by Fed Governor Frederic Mishkin late on Friday suggested the central bank may be comfortable with inflation at around 2 percent, rather than much lower. Mishkin said he was not optimistic about core inflation falling below 2 percent without a determined monetary policy effort.

The Fed may not be ready to make that push, which would likely result in slower growth and higher unemployment.

“The Fed will find it hard to explain to Congress and the public why it should put a million people out of work for two years to reduce inflation by half a point,” Morgan Stanley economist Richard Berner wrote in a note to clients.

Markets are betting the Fed is willing to live with slightly higher core inflation.

Inflation expectations, as reflected in the difference between yields on 10-year Treasury notes US10YT=RR and 10-year Treasury Inflation-protected Securities US912828FL9=RR, have widened to 2.48 percentage points, the widest gap in six months.

The spread widened 7 basis points after the Fed’s policy-setting meeting March 21. A basis point is 1/100th of a percentage point.

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