By Nell Henderson and Tomoeh Murakami Tse
Washington Post Staff Writers
Thursday, February 15, 2007
Federal Reserve Chairman Ben S. Bernanke indicated yesterday that the central bank is likely to hold interest rates steady, prompting a rally on Wall Street that pushed the Dow Jones industrial average to a record high.
The Fed chief told the Senate Banking Committee that he and his colleagues believe inflation is too high and that they're concerned it might stay that way. But it's more likely, Bernanke said, that a cooling economy will dampen price pressures this year.
Therefore, Fed policymakers don't think they will have to hike rates further to bring inflation down this year and next, Bernanke said. Conversely, they don't think they need to cut rates anytime soon to spur growth.
"The current stance of policy is likely to foster sustainable economic growth and a gradual ebbing of core inflation," Bernanke said, presenting the Fed's first economic report to Congress this year.
Those words were "music to the ears of both stock and bond investors," said Stuart Hoffman, chief economist for PNC Financial Services Group. "The Fed doesn't see the economy in any real trouble."
The Dow closed at 12,741.86, up 87.01 points, or 0.69 percent, on top of a 102-point gain Tuesday. Yesterday's close beat the record set Feb. 1.
Bernanke outlined expectations of a "Goldilocks" economy -- not too hot, not too cold, with moderating inflation -- said Arthur Hogan, chief market analyst at Jefferies. "The general theme of his testimony was on the neutral side. . . . I think that's what the markets have been celebrating."
Democratic and Republican senators also welcomed Bernanke's message, and praised his performance since succeeding Alan Greenspan as Fed chairman a year ago.
"I believe that you have done a very good job in gaining the respect and confidence of the markets and your colleagues on the Federal Reserve Board," the committee chairman, Christopher J. Dodd (D-Conn.), told Bernanke. "The Fed's monetary policy, most notably its decision to stop raising interest rates in June, has played a very important role in some recent positive economic developments."
Fed policymakers have held their benchmark short-term interest rate steady at 5.25 percent since June. Many analysts predict the rate will stay at that level through the rest of the year.
However, after the Commerce Department reported yesterday that retail sales were flat last month, some traders boosted their bets that the Fed will cut interest rates by the end of the year to boost growth. The sales figures added to other recent data showing the economy entered the new year with less momentum than previously thought.
Many analysts now estimate that the economy grew at a sluggish pace in the last three months of the year, close to a 2 percent annual rate -- well below the robust 3.5 percent pace estimated recently by the Commerce Department. The agency will update its estimate at the end of this month.
Bernanke indicated he is comfortable with the latest news, as it fits with the Fed's forecast that a period of moderate economic growth will force inflation lower.
"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," he said.
The economy has grown more than 3 percent a year for the last three years. This year, the economy will grow 2.5 to 3 percent, the Fed's top policymakers forecast in their report to Congress.
They predicted this slowdown would cause core inflation, which excludes volatile food and energy prices, to drift gradually from 2.2 percent last year to below 2 percent by 2008. The Fed has no formal target, but Bernanke and several of his colleagues have said they prefer to hold core inflation within a "comfort zone" of 1 to 2 percent.
Fed policymakers also foresee unemployment edging up a bit but remaining low this year and next. The jobless rate was 4.5 percent at the end of last year. The Fed expects it to average 4.5 to 4.75 percent at the end of this year, and to stay about there in 2008.
Bernanke attributed most of the slowdown to the housing slump. But he said that weakness does "not seem to have spilled over to any significant extent to other sectors of the economy."
Indeed, the economy is following the Fed's script so well, Bernanke "might want to do a touchdown dance at their next meeting," said Ethan S. Harris, chief economist at Lehman Bros.