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Thursday, July 20, 2006

Bernanke Hints at a Pause

By Yaser Anwar, CSC of Equity Investment Ideas

Federal Reserve Chairman Ben Bernanke hinted that the Fed may be finished raising interest rates, at least for now. Bernanke testified before the Senate Banking Committee today, telling members that past rate hikes have not fully worked their way through the economy, despite signs of inflation.

"We must take account of the possible future effects of previous policy actions -- that is, of policy effects still in the pipeline," Bernanke said to the Committee. "The extent and timing of any additional firming that may be needed to address inflation risks will depend on the evolution of the outlook for both inflation and economic growth."

It typically takes six months for interest rate hikes to fully impact the economy. That means the March, May, and June rate hikes have not yet done their part to curb inflation.

Meanwhile, the economy is slowing substantially. According to the Feds estimates, economic growth as measured by gross domestic product will likely slow to 3.25 percent to 3.5 percent this year, from a blistering growth rate of 5.6 percent in the first quarter. It puts growth for 2007 at 3 percent to 3.25 percent.

"The lags between policy actions and their effects imply that we must be forward-looking, basing our policy choices on the longer-term outlook for both inflation and economic growth," he said.

In other words, despite todays higher-than-expected core inflation readings (more below), Bernanke believes that the Fed will have to rely on its forecasts rather than the hard data.

"We must not consider not only what appears to be the most likely outcome, but also the risks to that outlook and the costs that would be incurred should any of those risks be realized," Bernanke said. "Policy must be flexible and ready to adjust to changes in economic projections."

But, Bernanke did say the Fed will continue to be vigilant when it comes to inflation. "The recent rise in inflation is of concern," said Bernanke. "Persistently higher inflation would erode the performance of the real economy and would be costly to reverse. The Federal Reserve must take account of these risks in making its policy decisions."

But for now, it looks highly likely that the Fed will pause in its rate-hiking cycle.

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