- The Washington Times - Wednesday, July 19, 2006

Federal Reserve Chairman Ben S. Bernanke sparked a major market rally yesterday by saying the central bank expects the slowdown in economic growth that started this spring to temper the threat of inflation stemming from high energy prices.

Mr. Bernanke told the Senate Banking, Housing and Urban Affairs Committee that higher inflation remains the biggest risk facing the economy, but the Fed also recognizes the risks to growth from high oil prices, a rapidly declining housing market and flare-ups of violence in the Middle East.

His remarks, which toned down more hawkish rhetoric used by Fed officials this spring that rattled the markets, sparked an elated reaction on Wall Street, where many feared the central bank would overdo raising interest rates and cripple the economy.

The Dow Jones Industrial Average surged 212 points to 11,011, helped along by talk of a cease-fire in Lebanon and a decline in oil prices from record levels set last week.

“The anticipated moderation in economic growth now seems to be under way,” Mr. Bernanke said, but “there are risks in both directions.” The Fed could raise rates too high and damage the economy, but it also runs the risk of not doing enough to curb inflation, which poses a formidable threat to economic growth in the long run, he said.

While members of Congress and the real estate industry have been complaining that the Fed is in danger of killing off home sales by engineering sharply higher short-term rates, Mr. Bernanke noted that mortgage rates at five-year highs are still only a fraction of the record 18 percent level hit as a result of high inflation in 1980.

Yesterday, a report of an additional 5.3 percent fall in housing starts, bringing new home building to the lowest levels since 2003, highlighted what Mr. Bernanke said was the clear evidence that the once-booming housing market is leading the transition to slower growth that the Fed has sought.

He said he expects spending by consumers to follow suit, cooling in response to a decline in housing wealth and home equity extraction, as well as the decline in purchasing power caused by fast-rising energy costs. Weak retail sales this summer have provided evidence of an emerging consumer slowdown.

But the payoff from slower growth — a reduction in inflation — has yet to arrive, Mr. Bernanke said. Just before his appearance on Capitol Hill, the Labor Department reported that consumer prices rose at a 5.1 percent annual rate in the past three months mostly as a result of soaring energy costs — more than double what the Fed considers an acceptable pace.

The Fed remains concerned about this year’s rash of inflation, Mr. Bernanke said, but is taking a longer view and thinks that by next year, the surge in inflation will subside.

“We can’t do anything about this month’s inflation number because our policy works with a lag,” he said.

The consumer price report showed that inflation ran at a 3.6 percent pace, even excluding volatile energy and food costs, largely because of a pickup in rental housing costs.

But Mr. Bernanke said the measure of housing costs used by the department may be flawed, and that is one reason the central bank relies heavily on other price measures. He cited a measure published by the Commerce Department that showed “core” inflation running at a tamer 2.6 percent rate.

One reason the Fed is worried that inflation will persist rather than flare temporarily is the unrelenting increase in energy costs, Mr. Bernanke said. He noted that energy spikes often were quickly retraced in past years, but high oil prices seem to have more lasting power today and forecasts of lower prices have been “consistently disappointed.”

That is why the Fed must remain vigilant, he said. “Persistently higher inflation would erode the performance of the real economy and would be costly to reverse.”

Some Fed watchers said that the markets may have overreacted to Mr. Bernanke’s choice of milder terms to describe his inflation concerns.

“While Bernanke used relatively soft language, his message was clear,” said Roger M. Kubarych, economist at HVB Group. “The Fed intends to keep tightening monetary policy until it is certain that core inflation is going to recede.”

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