Bernanke Pulled in Different Directions by Economy (Update1)
May 31 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke is pulled in opposite directions by worries over inflation and housing, leaving him little choice other than to keep interest rates unchanged.
Fed officials said they still expect a pickup in the economy this year and view inflation as their main concern, minutes of their May 9 meeting showed yesterday. They listed several caveats, including the risk that the housing recession may ``weigh heavily'' on growth.
Still, officials said the risks of a slowdown have ``diminished slightly.'' Futures trading indicates the chance of a rate cut by the end of December has dropped to 40 percent, the lowest this year. As recently as March, investors saw a half- point reduction as certain.
``If you don't quite understand how the economy's functioning, then there's a temptation to take the view that anything you do to interfere could turn out to be perverse,'' said Neal Soss, chief economist at Credit Suisse in New York, who was an adviser to former Fed Chairman Paul Volcker. ``Therefore, you're better off doing nothing.''
Consumer spending is countering the effect of the housing slump, helped by gains in income and employment, and business investment is likely to accelerate, the minutes said.
Yearlong Pause
The Fed has kept the overnight lending rate between banks at 5.25 percent since June 2006, after 17 quarter-point increases over the prior two years. Soss forecasts policy makers will leave the rate unchanged into 2008.
``The correction of the housing sector was likely to continue to weigh heavily on economic activity through most of this year -- somewhat longer than previously expected,'' the minutes said.
A slide in residential real estate investment lopped almost 1 percentage point off growth in the first quarter, helping to bring it down to an annual pace of 0.6 percent, the weakest since the last three months of 2002, according to revised figures from the Commerce Department today.
Sales of existing homes fell 2.6 percent in April to a four-year low, an industry report showed last week. House prices in the U.S. also dropped last quarter for the first time in almost 16 years, according to the S&P/Case-Shiller index.
`Protracted Downturn'
Fed policy makers ``cannot raise rates without pushing mortgage rates higher, leading to a more protracted downturn in housing,'' said Keith Hembre, chief economist at Minneapolis- based U.S. Bancorp's FAF Advisors Inc., which manages $105 billion. ``They are on hold until something comes along that challenges their outlook for the second half of the year and 2008.''
Two-year Treasury notes were little changed after yesterday's minutes. The yield on the benchmark note due in 2009 declined 2 basis points yesterday to 4.88 percent.
The Fed's Open Market Committee anticipates growth will ``pick up to a rate broadly in line with the economy's trend rate in 2008,'' the minutes showed. Central bankers including Kansas City Fed Bank President Thomas Hoenig and San Francisco Fed chief Janet Yellen estimate the trend rate at around 3 percent.
Almost all Fed policy makers consider inflation to be ``uncomfortably high,'' the minutes added. The central bank's preferred price gauge, which excludes food and energy costs, has for three years run at or above 2 percent, the top of the comfort range for at least six Fed officials.
Inflation Rate
The Fed's preferred inflation measure rose at a 2.2 percent annual rate in the first quarter.
``Although readings on core inflation in March had been more favorable, this followed several months of elevated inflation data,'' the minutes said. ``All participants agreed that the risks around the anticipated moderation in inflation were to the upside; and some noted that a failure of inflation to moderate could entail significant costs.''
Most FOMC members consider the low rate of unemployment to be one of those risks, the minutes showed. The jobless rate was 4.5 percent in April, close to a five-year low.
Policy makers discussed the disparity between the slowing economy and a ``relatively strong'' job market, the minutes showed. Difficulties with measuring output and construction employment may be one explanation, officials said. Another may be that the economy's so-called speed limit, the maximum pace it can grow without heating up inflation, is lower than in the past, according to the minutes.
The Fed said export demand, along with consumer spending and a strong job market, will buoy growth.
``Recent developments were seen as supporting the Committee's view that maintaining the current target rate was likely to foster moderate economic growth and a gradual ebbing in core inflation,'' the minutes said.
**original source = bloomberg**
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