labels: industry - general
US Fed signals likely pause in rate hikes on easing inflation news
20 July 2006

US Fed chairman Ben Bernanke expects US inflation to ease over the next couple of years as economic growth slows down to a more moderate pace. In his testimony to the banking committee of the US Senate, the Fed chief gave many indications that the Fed would prefer to stop raising interest rates if economic indicators give enough signs of a slowdown.

Statements by Bernanke clearly indicated that the Fed is worried about hiking interest rates too far and causing a considerable decline in economic growth rates. US stock markets rallied yesterday after the testimony on expectations that the Fed would indeed stop hiking interest rates, at least for a brief period.

The Fed expects the US economy to real GDP to increase about 3.25 per cent to 3.5 per cent in 2006 and 3 per cent to 3.25 per cent in 2007. "Overall, the US economy seems poised to grow in coming quarters at a pace roughly in line with the expansion of its underlying productive capacity," Bernanke said in a prepared statement read out before the Senate committee.

"The US economy appears to be in a period of transition. After several years of above-trend growth, slack in resource utilisation has been substantially reduced. As a consequence, a sustainable, non-inflationary expansion is likely to involve a modest reduction in the growth of economic activity from the rapid pace of the past three years to a pace more consistent with the rate of increase in the nation's underlying productive capacity", Bernanke said in the statement.

The Fed is maintaining its outlook on global economic growth. "Globally, output growth appears strong. Growth of the global economy will help support US economic activity by continuing to stimulate demand for our exports of goods and services. One downside of the strength of the global economy, however, is that it has led to significant increases in the demand for crude oil and other primary commodities over the past few years", the statement said.

Bernanke said projections by the Fed based on current data are "for a gradual decline in inflation in coming quarters. As measured by the price index for personal consumption expenditures excluding food and energy, inflation is projected to be 2.25 per cent to 2.5 per cent this year and then to edge lower, to 2 per cent to 2-.25 per cent next year."

But the Fed remains conscious of the inflationary risks facing the US economy. "Although our baseline forecast is for moderating inflation, the Committee judges that some inflation risks remain. In particular, the high prices of energy and other commodities, in conjunction with high levels of resource utilisation that may increase the pricing power of suppliers of goods and services, have the potential to sustain inflation pressures. Persistently higher inflation would erode the performance of the real economy and would be costly to reverse", the statement added.

On crude oil prices the statement said, "The spot price of oil has moved up significantly further in recent weeks. Futures quotes imply that market participants expect petroleum prices to roughly stabilise in coming quarters; such an outcome would, over time, reduce one source of upward pressure on inflation. However, expectations of a levelling out of oil prices have been consistently disappointed in recent years."

The Fed is more worried about the impact of rising wages on inflation. "Although the costs of energy and other raw materials are important, labour costs are by far the largest component of business costs. Employee compensation per hour is likely to rise more quickly over the next couple of years in response to the strength of the labour market."

"Whether faster increases in nominal compensation create additional cost pressures for firms depends in part on the extent to which they are offset by continuing productivity gains. Profit margins are currently relatively wide, and the effect of a possible acceleration in compensation on price inflation would thus also depend on the extent to which competitive pressures force firms to reduce margins rather than pass on higher costs" , Bernanke said in the statement.

Bernanke defended the last rate hike by the Fed to 5.25 per cent, saying inflation has been higher than anticipated. "During the first five months of the year, overall inflation averaged 4.3 per cent at an annual rate. Over the same period, core inflation — that is, inflation excluding food and energy prices — averaged 2.6 per cent at an annual rate. To address the risk that inflation pressures might remain elevated, the Federal Open Market Committee (FOMC) continued to firm the stance of monetary policy", he said.

 search domain-b
US Fed signals likely pause in rate hikes on easing inflation