By Nell Henderson
Washington Post Staff Writer
Thursday, July 20, 2006; D01
Federal Reserve Chairman Ben S. Bernanke said yesterday that the central bank remains worried about rising inflation, but he did not signal any immediate plan to raise interest rates again to combat it, sending stock prices soaring in relief.
Bernanke, testifying on Capitol Hill, did say the possibility of worsening inflation is the biggest threat to the U.S. economy, suggesting the Fed would combat that danger if necessary by raising interest rates in coming months.
But the Fed chairman also left open the possibility that the Fed may pause, at least briefly, after two years of steady interest-rate increases, taking no action at its next policymaking meeting, on Aug. 8.
"We will be evaluating all options when we come to meet in August," Bernanke told the Senate Banking Committee as he presented the Fed's economic forecasts for the next 18 months.
Markets rallied around the world. The Dow Jones industrial average jumped 212 points, or nearly 2 percent. Some analysts described the financial markets' reaction as a "relief rally" because Bernanke did not signal firm plans for another rate hike in August. Many traders had braced for a tougher warning after the Labor Department released a worrisome inflation report yesterday morning, before the chairman testified.
Stocks were also rebounding yesterday after dropping sharply late last week, when the escalating Middle East conflict pushed oil prices above $78 a barrel, fanning market fears of both higher inflation and slower economic growth, analysts said.
"The markets were looking for a reason to rally after several miserable trading sessions," said Richard Yamarone, director of research at Argus Research Corp. But, he added, "I think the markets got it all wrong . . . if they think the Fed is pretty much close to being done" raising interest rates.
Indeed, Bernanke stressed that Fed policymakers remain worried that consumer prices have risen more this year than expected, partly because of sharply rising prices for oil and other raw materials.
The Labor Department reported that its consumer price index moderated in June but is up 4.3 percent over the past 12 months -- a significant jump from 3.4 percent inflation in 2005.
More troubling to many economists was the fourth consecutive 0.3 percent monthly increase in the "core CPI," which excludes volatile food and energy prices and is seen as a measure of the ability of businesses to pass higher fuel and other costs to their customers.
Other measures of core inflation are up as well, Bernanke noted, adding that "the recent rise in inflation is of concern" to the Federal Open Market Committee, the central bank's top policymaking group.
The committee forecasts that its preferred measure of core inflation will rise this year and then slip a bit next year as the economy slows, according to the report Bernanke delivered to Congress. But that would leave inflation next year at 2 percent or higher, which is above the chairman's desired range.
The biggest threat to the economy, Bernanke said twice in response to questions, would be for inflation to flare higher than expected. That would force the Fed to raise interest rates more aggressively, boosting the risk of a recession, he said.
Among the reasons to worry, he said, are rising oil prices, which have more than doubled from less than $30 a barrel in 2003 to above $70 today. Strengthening global growth and persistent geopolitical tensions threaten to drive the prices of oil and other raw materials still higher, he said.
Fed policymakers also worry that higher prices might cause consumers and businesses to expect them to keep rising, with inflation thus becoming a self-fulfilling prophecy.
The Fed does expect U.S. economic growth to slow modestly from its rapid pace of the past three years to a solid rate just above 3 percent next year. And that, Bernanke said, "should help to limit inflation pressures over time."
But he also emphasized that forecasts can be wrong and said the Fed would continue to use former chairman Alan Greenspan's "risk management" approach to interest-rate policy. That means basing policy not only on the most likely outcome, but also guarding against results that might be less probable but more harmful.
The Greenspan Fed, for example, lowered its benchmark rate to 1 percent in 2003 to guard against the possibility of deflation -- an economically destructive decline in the overall price level.
Today, the Bernanke Fed's comparable worry is that inflation might take off. The debate within the Fed is whether higher interest rates will be needed to slow the economy enough to prevent that from happening.
Some senators suggested the Fed has raised rates enough, and perhaps too much. "Inflation is not out of control," said Sen. Jim Bunning (R-Ky.), a frequent Fed critic. "The Fed is chasing an inflation monster that is just not there."
Bernanke said the Fed does not want to raise rates so high as to choke growth, but he appeared to play down that danger by saying he did not "see a recession as being very likely."
The Fed policymakers' forecast of inflation next year shows that they are "not willing to take rates to a point that would reduce inflation immediately but raise the risk of recession," said Mickey Levy, chief economist at Bank of America Corp. Rather, they are willing to tolerate inflation above 2 percent temporarily if it is drifting lower, and if inflation expectations are under control, he said.
Despite many investors' hopes for an August pause, Levy is among the analysts who predict the Fed will raise its benchmark short-term rate again at the next meeting, by another quarter of a percentage point, to 5.5 percent.
"While the markets rallied significantly," he said, "the Fed left open the possibility of raising rates as deemed appropriate."
As the Bernanke-inspired rally played out in markets around the world, the Dow rose 212.19, or 1.96 percent, to close at 11,011.42. Broader stock indicators also gained sharply. The Standard & Poor's 500-stock index rose 22.95, up 1.86 percent, to 1259.81, and the Nasdaq composite index rose 37.49, or 1.83 percent, to 2080.71.Movers
International Business Machines rose $1.81, to $76.07, after it reported second-quarter earnings that beat analyst estimates.
Bank of America rose $1.51, to $49.95, after it said its acquisition of MBNA helped lift second-quarter profit above Wall Street projections.
J.P. Morgan Chase rose $2.34, to $43.05, after the nation's third-largest bank reported strong second-quarter profit growth.Indexes
New York Stock Exchange composite index rose 178.29, to 8076.65.
American Stock Exchange index rose 28.74, to 1911.54.
Russell 2000 index of smaller-company stocks rose 20.70, to 702.34.Volume
NYSE: 2.83 billion shares, up from 2.58 billion on Tuesday. Advancers narrowly outnumbered decliners 6 to 1.
Nasdaq: 2.35 billion shares, up from 2.04 billion. Advancers narrowly outnumbered decliners 10 to 3.Commodities
Crude oil for August delivery: $72.66, down 88 cents.
Gold for current delivery: $641.60 a troy ounce, up from $628.30 on Tuesday.
The Associated Press contributed to this report