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Fed chief sanguine on prices, growth

Bernanke expects lower inflation and moderate expansion, boosting the `soft landing' scenario.

February 15, 2007|Molly Hennessy-Fiske | Times Staff Writer

WASHINGTON — Federal Reserve Chairman Ben S. Bernanke told Congress on Wednesday that he was generally pleased with the slow-growing economy and sees inflation pressures easing, reinforcing the widespread view that the central bank won't raise interest rates soon.

Analysts feared a dour forecast, based on the housing slowdown and inflation lingering at a 2.5% rate last month, half a point above the upper limit of the Fed's comfort zone. After Bernanke's remarks, many were optimistic that the economy was coasting to a soft landing, and stocks rallied while bond yields fell.

"The U.S. economy appears to be making a transition from the rapid rate of expansion experienced over the preceding several years to a more sustainable, average pace of growth," Bernanke told the Senate Banking Committee during his semi-annual report to Congress.

Analysts interpreted his remarks as suggesting the Fed would leave interest rates alone until it sees warning signs of a significant uptick in inflation or downturn in growth.

Bernanke said he expected the economy to expand at a "moderate pace" of between 2.5% and 3% this year and between 2.75% and 3% in 2008. That's less than the 3.4% growth seen last year and less for this year than Bernanke had predicted in July.

He said the Fed downgraded its growth forecast due to greater-than-anticipated weakness in residential construction, including a 30% drop in single-family housing starts since the beginning of last year and a "substantial" slowdown in construction employment.

Bernanke said consumer spending, which is credited with largely driving economic growth, is likely to "expand solidly in coming quarters." The Commerce Department reported Wednesday that retail sales remained flat in January, due to lagging auto sales, disappointing analysts who had predicted a 0.3% increase.

Bernanke said pricing pressures "abated somewhat" during the second half of 2006 as core inflation -- excluding food and energy costs -- fell from 2.8% in the first quarter to 1.4% in the fourth.

Bernanke predicted core inflation would continue to fall this year and said futures markets indicated oil prices also were likely to fall, bringing down overall inflation from last year's average of 2.6%.

But the Fed chairman warned that inflation could still rise because of wage pressure in a tight labor market. Last month, average hourly earnings rose 0.2% after rising 0.4% in December, and unemployment rose from 4.5% to 4.6%. The Fed expects unemployment to hover between 4.5% and 4.75% by year's end, Bernanke said, and remain there at the end of 2008.

The Fed made no change to its benchmark short-term interest rate at its most recent meeting last month, holding steady at 5.25%, the fifth pause since July. Before that, the Fed had been on an inflation-fighting campaign, raising rates by a quarter of a percentage point for 17 straight meetings since 2004.

After Bernanke's glowing report to Congress on Wednesday, analysts predicted the Fed would continue to hold off on raising interest rates until late this year, if at all.

Based on Bernanke's comments, "the Fed doesn't see a risk from growth or inflation," said University of Maryland economist Peter Morici.

Morici predicts the Fed won't change rates at its next few meetings, although energy prices will probably rise and prompt a rate hike later in the year. He called Bernanke's report "sensible" and surprisingly upbeat.

"I didn't expect him to be so dovish on inflation," Morici said. "I think the market was surprised."

Mickey Levy, chief economist at Bank of America Corp. in New York, said it was Bernanke's delivery as much as the data he summoned that reassured investors.

"It showed a considerable amount of confidence that they're doing things right. It, in and of itself, built credibility," Levy said.

On Wednesday, several Banking Committee members attempted to take advantage of Bernanke's willingness to discuss monetary policy, trying to score endorsements of particular policies, from President Bush's tax cuts to free trade pacts and curbs on foreign currency manipulation.

Bernanke refused to weigh in on the issues, including the decision to extend Bush's tax cuts, which he called "a value judgment."

But overall, committee members were supportive of Bernanke's handling of monetary policy as well as his commitment to increase the transparency of Fed communications.

"My initial fears were you would be a carbon copy of your predecessor. Yet you have done something I have never seen your predecessor do -- embrace open debate," Sen. Jim Bunning (R-Ky.) said.

He added: "You inherited an economy at the tipping point and you have managed not to push it over."

molly.hennessy-fiske@latimes .com

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