Wednesday, November 29, 2006

Economy's weakness shows - Fed chairman unfazed, still targeting inflation

Economy's weakness shows - Fed chairman unfazed, still targeting inflation
By William Neikirk
Copyright © 2006, Chicago Tribune
Published November 29, 2006

WASHINGTON -- New signs appeared Tuesday that the economy is stuck in a slowdown, but Federal Reserve Chairman Ben Bernanke made it clear he's more worried about inflation and is not prepared to cut interest rates anytime soon.

The head of the nation's central bank said in a speech in New York that the core inflation rate, which excludes food and energy costs, "remains uncomfortably high" and could trigger an interest rate increase if not brought under control.

Over the next year, he said, the economy likely will pick up strength and grow at a modest but sustainable rate without further interest rate reductions.

His remarks dashed widespread assumptions on Wall Street that the weakening economy could cause the Fed to reduce interest rates over the next several months.

Bernanke made his remarks on a day that three economic indicators--consumer confidence, home prices and durable goods orders--appeared to signal a tapering of economic growth as the holiday shopping season begins to gather steam.

The next few days will provide a clearer picture of how consumers are spending in an economically crucial time of year, analysts said, as more figures come in from retailers across the country.

So far, based on anecdotal evidence, retail sales appear to be more sluggish than expected.

Before Bernanke spoke, the National Association of Manufacturers' chief economist, David Huether, citing an 8.3 percent decline in durable goods orders in October, said, "It's time for the Federal Reserve to consider easing monetary policy sooner rather than later."

But the Fed chief appeared unconcerned about such worries over economic growth.

Other than the housing and automobile markets, Bernanke said, the economy appears strong and likely will look healthy going into next year.

The core inflation rate was 2.7 percent in October. The Fed has indicated it is comfortable when the overall increase in prices is 2 percent or lower.

Bernanke said a tight labor market could be pushing up wages and prices. He added that the economy has less spare capacity to produce goods, and that also could be contributing to the inflation rate.

"Given the current level of inflation, a failure of inflation to moderate as expected would be especially troublesome," he said.

The stock market took his statements in stride, closing slightly higher, but the bond market rallied on the statements about inflation.

According to Chicago economist Diane Swonk of Mesirow Financial, one reason that Bernanke emphasized inflation is that he is a relatively new chairman, and he and other members of the central bank want to establish their credibility in controlling inflation.

Laurence Kotlikoff, an economics professor at Boston University, said Bernanke appeared to be "jawboning" companies, employees and financial markets to keep wages, prices and inflation expectations in line, or else the central bank might be forced to raise interest rates.



Rate cuts were forecast

Carl Tannenbaum, an economist at LaSalle Bank in Chicago, said financial markets expected interest rates to be cut once, possibly twice, in 2007. Now, with Bernanke's statement, there's a good chance interest rates will remain steady throughout next year and possibly could be increased, he said.

The economy slowed to a 1.6 percent annual growth rate in the third quarter, according to the first reading of the gross domestic product, the value of the nation's output of goods and services.

Many analysts expect that a revision of that number, due Wednesday, will show only a small increase in growth from the original estimate.

Bernanke said he expected economic growth will be similarly slow in the fourth quarter, but added, "Over the next year or so, the economy appears likely to expand at a moderate rate, close to or modestly below the economy's long-term sustainable pace." That appeared to indicate he expects an annual growth rate of 3 percent to 3.5 percent.

Swonk said the slowdown under way should not be severe and could lead to a slight rise in the nation's unemployment rate, now at 4.4 percent. She said the housing correction "probably will be done by the end of the year."



Home prices off sharply

According to the National Association of Realtors, the median price of a home fell to $221,000 in October, down 3.5 percent from a year ago. This was the largest one-year price decline on record.

At the same time, existing-home sales rose 0.5 percent, a sign that the bottom has not dropped out of the market.

Nonetheless, cutbacks in new-home construction and layoffs in the auto industry have contributed to concerns among consumers about the health of the economy.

In New York, the Conference Board, a business group, said its index measuring consumer confidence fell to 102.9 in November from 105.1 in October, below what many economists had expected.

But Tannenbaum said he isn't ready to give up on consumers, whose spending accounts for about two-thirds of economic activity, despite these negative reports.

"I am guardedly optimistic that consumers are in pretty good shape," he said, citing lower oil prices and a relatively good job market.

He predicted the economy would rebound and grow at a 3 percent annual rate in the fourth quarter, then rise by an estimated 2.5 percent to 3 percent in 2007.

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wneikirk@tribune.com

MEDIAN HOME PRICES

-3.5%

From October 2005 to October 2006, the biggest year-over-year decline on record.

DURABLE GOODS

-8.3%

Drop in orders from September-October, the biggest decline in more than six years.

CONSUMER CONFIDENCE

102.9

Index reading in November, down from 105.1 in October and the lowest figure since August.

Source: AP

Chicago Tribune

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