So far, the data support Fed's rate pause

August 18, 2006|By BLOOMBERG NEWS

WASHINGTON -- Federal Reserve Chairman Ben S. Bernanke's gamble that he can suspend interest rate increases on the chance inflation will recede is showing signs of paying off.

Economic figures are breaking Bernanke's way for the first time since he took the central bank's helm in February. A measure of wholesale prices unexpectedly fell last month and one gauge of consumer inflation eased, according to Labor Department numbers reported this week. Reports of slowing sales from Wal-Mart Stores Inc. and Home Depot Inc. also provided evidence backing the Fed's forecast of a slowing economic expansion.

"The wisdom of a pause is looking more and more solid," said Stuart G. Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh and a former Fed economist."The very recent data are consistent with the idea of the soft landing, slowing growth," he said.

The Fed decided Aug. 8 to keep its benchmark lending rate at 5.25 percent, predicting that consumer prices will "moderate over time."

The Fed's 17 previous rate increases, surging energy prices and a cooling housing market would reduce inflationary pressure, the Fed said.

On Monday, Wal-Mart blamed higher gasoline prices in reporting its smallest sales gain at its U.S. stores in six quarters. Home Depot blamed mortgage payments for its first decline in sales in three years at stores open a year.

"The evidence so far suggests that Bernanke may be right," said Anthony Chan, chief economist at JPMorgan Private Client Services in New York and a former Fed economist. "With slower economic growth, we will eventually see lower price pressures. The trends are moving in the right direction."

The government's Consumer Price Index, excluding food and energy, rose 0.2 percent last month, the smallest increase since February, the Labor Department said Wednesday.

The Labor Department had reported the day before that prices paid to producers, excluding food and energy, unexpectedly fell in July. The wholesale price report triggered a rally in bonds that pushed 10-year Treasuries to the lowest yields since April.

Investors now speculate Bernanke's rate-raising work may be done. Yields on interest-rate futures contracts suggest a less than 50 percent chance the Fed will lift the federal funds rate on overnight loans between banks to 5.5 percent by the end of the year. Before the report on wholesale prices, traders put the likelihood at greater than 70 percent.

"This is welcome relief," said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York and a former head of domestic research at the New York Fed. "This justifies the breathing room the Fed's trying to create."

Even so, Harris warned that inflation may pick up again in coming months, forcing the Fed to resume its rate increases.

Fed officials still believe that the dangers of higher inflation outweigh the risk of a significant economic slowdown. Companies say they need to raise wages to attract workers, and have the ability to pass along those costs to consumers, said Richard W. Fisher, president of the Federal Reserve Bank of Dallas, in a speech Wednesday.

Bernanke first flagged a possible rate pause in late April even as prices were climbing.

"It looked like a dicey call" when the Fed began considering halting its increases, said Barr Z. Segal, a managing director at TCW Group Inc. in Los Angeles, who helps oversee $54 billion in fixed-income assets. Now, he said, "they've got to be high-fiving over there."

Bernanke will have wholesale and consumer inflation reports for August in hand, as well as the August employment report, before the next meeting of Fed policy makers Sept. 20.

Anecdotal data from retailers, auto dealers and home sellers will also help mold the Fed's view of the most likely economic course. Most recent reports are showing a pronounced slowdown, said Chan, the JPMorgan economist.

Alan Greenspan, Bernanke's predecessor at the Fed, used to pay attention to Wal-Mart reports among others, Chan said.

Higher interest rates have triggered a slump in the housing industry. They are also squeezing consumers - particularly those with adjustable-rate mortgages, who must put more of their incomes toward those payments, leaving less for other spending, such as on cars.

U.S. sales of cars and light trucks for the year through July 31 fell 4.9 percent. Sales last quarter in California, where a large chunk of home mortgages have variable rates, fell 14 percent from a year ago, compared with a 7 percent decline nationwide, said Michael J. Jackson, chief executive officer of AutoNation Inc., the largest U.S. car dealer.

Fed officials anticipate that the growth of the nation's gross domestic product (GDP) for the second half of the year will stay near the second-quarter rate of 2.5 percent, eventually containing inflation, according to forecasts presented to Congress in July. The GDP is the value of goods and services produced in the U.S.

"Fears that we are going to have an inflation acceleration are no longer justified," said Donald Ratajczak, an economic consultant at Morgan Keegan & Co. who researched prices at the economic forecasting center he founded at Georgia State University in Atlanta.

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