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Inflation, housing woes and strains in financial markets pose downside risks to growth

WASHINGTON - FEDERAL Reserve chairman Ben Bernanke told Congress yesterday that the fragile United States economy was being confronted by ‘numerous difficulties’, including persistent strains in financial markets, rising joblessness and housing problems.
And all these despite the Fed’s aggressive interest-rate cuts and other fortifying steps over the past year.

At the same time, Mr Bernanke, testifying before the Senate Banking Committee, sounded another warning that rising prices for energy and food were elevating inflation risks.

The situation, he said, poses ’significant challenges’ for Fed policymakers as they try to chart the best course for keeping the economy growing, while ensuring inflation does not flare up.

All the economy’s problems, including slumping home values, which threaten to make people feel less wealthy and less inclined to spend in the months ahead, represent ’significant downside risks’ to economic growth.

Over the rest of this year, the economy will grow ‘appreciably below its trend rate’, mostly because of continued weakness in housing markets, high energy prices and tight credit conditions.

Inflation has remained high and ’seems likely to move temporarily higher in the near term’, Mr Bernanke warned.

Indeed, before he testified, the Labour Department reported that wholesale prices jumped 1.8 per cent last month. That left inflation rising over the past year at the fastest pace in more than a quarter-century.

Retail sales rose 0.1 per cent from the previous month, the Commerce Department reported yesterday, lower than economists had forecast.

‘Helping the financial markets return to more normal functioning will continue to be a top priority of the Federal Reserve,’ the Fed chairman said.

‘Given the high degree of uncertainty’ about the economic outlook, the central bank’s policymakers will need to carefully assess incoming information about inflation and economic growth, he added.

Mr Bernanke’s comments are his first on monetary policy and the economic outlook since the Federal Open Market Committee’s June 25 decision to leave the benchmark interest rate unchanged at 2 per cent, pausing after seven cuts totalling 3.25 percentage points since September last year.

The Fed had ended its nearly year-long rate-cutting campaign because of growing concerns about inflation.

Mr Bernanke kept up his tough anti-inflation talk yesterday, but stressed many other problems that could short-circuit economic growth.

He seemed to be keeping his options open in terms of rates. Given all the risky cross-currents, economists believe the Fed will leave rates alone when it meets on Aug 5.

Righting wobbly financial markets is key to getting the economy back on track, Mr Bernanke said.

‘In general, healthy economic growth depends on well-functioning financial markets,’ he said. ‘Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority.’

His testimony comes just two days after the Fed and Treasury Department came to the rescue of mortgage giants Fannie Mae and Freddie Mac, offering to throw them a financial lifeline. The companies hold or guarantee more than US$5 trillion (S$6.8 trillion) in mortgages - almost half of the nation’s total.

Mr Bernanke said investors are nervous in general because of the cloudy outlook for the economy and credit conditions, feeding a vicious circle that can be hard to break.

‘Many financial markets and institutions remain under considerable stress, in part because the outlook for the economy and, thus, for credit quality, remains uncertain.’

The Fannie Mae and Freddie Mac troubles came on the heels of the failure of IndyMac, a big bank.

The Fed, in new projections, now believes inflation will be higher this year than previously thought, with prices rising as high as 4.2 per cent under one inflation measure.

Growth for the year will be sluggish - at best, 1.6 per cent - but not as bad as previously forecast, helped by the government’s US$168 billion stimulus, including rebates.

The unemployment rate, which could rise as high as 5.7 per cent this year, remains unchanged from earlier projections.

Meanwhile, President George W. Bush yesterday urged lawmakers to move quickly in putting into force legislation designed to help prop up Fannie Mae and Freddie Mac, while declaring the US financial system to be ‘basically sound’.

He said the two troubled mortgage companies play a central role in the nation’s housing-finance system, and that government actions to help them were not bailouts, as the two would remain shareholder-owned companies.

The Dow Jones Industrial Average declined during Mr Bernanke’s speech, but rebounded on Mr Bush’s comments. Oil falling to US$138 a barrel, on hopes that the Fed will defend the US dollar, also helped the market.

After two hours of trading, the Dow was 47.07 points lower at 11,008.12. - ASSOCIATED PRESS, BLOOMBERG
 
Source : Straits Times - 16 Jul 2008