Fed Comments Trigger Stock Rally

Ben S. Bernanke
CBS
Federal Reserve Chairman Ben Bernanke signaled on Wednesday that a two-year campaign of raising interest rates may finally be coming to an end, triggering a huge rally on Wall Street.

Bernanke told Congress he believed the economy was slowing to a more sustainable pace and the slowdown would help to lower inflation pressures. The Fed has gradually pushed interest rates to a five-year high in an effort to keep inflation under control.

"The anticipated moderation in economic growth now seems to be under way," Bernanke said in delivering the Fed's twice-a-year economic report to Congress.

That was just what investors wanted to hear. The Dow Jones industrial average surged by 212.19 points to close at 11,011.42.

The rally came despite the fact that the Consumer Price Index for June showed that core inflation, excluding energy and food, rose by a worrisome 0.3 percent. Over the past three months it is up at an annual rate of 3.6 percent, far above the Fed's comfort zone of 1 percent to 2 percent.

Bernanke did say that the recent rise in inflation "is of concern," but he said the central bank was looking for inflation pressures to ease.

He said rising energy prices and a slowing housing market were cutting into consumer spending, which accounts for two-thirds of total economic growth.

But he said the slowdown was being cushioned by strength in business investment on new buildings and equipment.

Bernanke said that inflation has been slightly higher than the Fed anticipated when he delivered his first economic report to Congress last February, only weeks after he succeeded Alan Greenspan as chairman of the central bank.

Still, Bernanke predicted that the economic slowdown would help ease inflation pressures in coming months.

"In the absence of significant unforeseen developments, the economy should continue to expand at a solid and sustainable pace and core inflation should decline from its recent level over the medium term," Bernanke told the Senate Banking Committee.

Bernanke's remarks in early June calling a rise in core inflation "unwelcome" had sent stock prices plunging as investors feared that the central bank would feel the need to raise interest rates several more times, increasing the dangers of a recession.

In the economic forecast Bernanke delivered to Congress, the Fed predicted that the overall economy as measured by the gross domestic product would slow to around 3.25 percent to 3.5 percent this year, significantly below the sizzling 5.6 percent GDP growth turning in during the first three months of the year.

For 2007, the Fed predicted a further slowing to growth of around 3 percent to 3.25 percent.

This growth slowdown will help lower core inflation, excluding food and energy, by about one-quarter percentage point in 2007. The Fed forecast said core inflation could be as high as 2.5 percent this year but should drop to no higher than 2.25 percent next year.

Analysts said the Fed's forecast of moderating growth and moderating inflation made it more likely that the central bank will raise rates only one more time this year, at the Aug. 8 meeting.

The funds rate, the interest that banks charge each other, now stands at 5.25 percent, having been boosted in 17 quarter-point moves from a 46-year low of 1 percent back in June 2004.

"Investors are happy because Bernanke gave a fairly strong signal that the tightening cycle is just about over," said Mark Zandi, chief economist at Moody's Economy.com. "After the CPI report came out, investors were worried that Bernanke would be much more hawkish about inflation."

Bernanke heard complaints from some members of the Senate committee that further Fed rate hikes could run the risk of a more severe slowdown and possibly even a recession, given the drag on the economy from rising energy prices, the Fed rate hikes that have already occurred and a cooling housing market.

Bernanke said he did not believe a recession was a threat and he said the central bank was always trying to balance the risks of raising interest rates too much against the risks of not doing enough to keep inflation contained.

"Clearly, we don't want to tighten too much to cause our economy to grow more slowly than its potential," he told the committee. "We are very aware of that concern. We think about it. We look at it. We try to evaluate it."

Sen. Jim Bunning, R-Ky., who opposed Bernanke's nomination to be Fed chairman, said the Fed was overly concerned about inflation.

"Inflation is not out of control," he told Bernanke. "The Fed is chasing an inflation monster that is just not there."