Financial Times Editorial - Benign US slowdown
Financial Times Editorial - Benign US slowdown
Copyright The Financial Times Limited 2006
Published: July 21 2006 03:00 | Last updated: July 21 2006 03:00
For the first time in a while, the markets are singing - and with some reason. Ben Bernanke, chairman of the Federal Reserve, this week sketched out a scenario that everyone wants to materialise: a soft landing for the US economy. Having raised rates 17 consecutive times, the Fed's view was that the economy would probably now "expand at a solid and sustainable pace and core inflation should decline from its recent level", he told senators. Given that core US inflation - excluding energy and food - has risen by 0.3 per cent in each of the last four months, Mr Bernanke's assessment was notably upbeat. But the content of his message should not be oversimplified. For good reasons, the probability remains that the Fed will raise rates by another quarter point - to 5.5 per cent - at its next meeting in early August. Only after that is it likely to pause.
The most important question is whether the Fed has done enough in the past two years to squeeze inflation out of the economy. The probability is that it has. And, as the chairman pointed out, some of the effects of recent monetary tightening have yet to feed through. However, there are still material risks to this benign scenario. First, the Fed cannot be sure that inflation expectations - a significant cause in itself of higher prices - have stabilised at their recent lower levels. Second, there are signs of US firms regaining leeway to pass on higher prices to the consumer. Third, nobody can be sure oil prices will stabilise - as the futures market is predicting. Should a barrel of oil advance beyond $90 then all bets would be off. Given the volatile Middle East, this cannot be discounted.
In addition to these risks, Mr Bernanke must weigh two further considerations. First, the price of overshooting on interest rates is lower than undershooting. If the Fed were unnecessarily to raise rates next month again - something that can only be determined in retrospect - it would be a fairly simple matter to undo it later in the year or early next. Conversely, if the Fed kept rates on hold next month only to find that consumer prices were continuing to rise, the cost of correcting this would amount to more than just another quarter point rise.
Second, Mr Bernanke has been plagued by misinterpretation since he took over from Alan Greenspan, the world's most inscrutable public speaker, earlier this year. Specifically, the markets misunderstood what Mr Bernanke meant by an interest rate "pause" when he raised that prospect in April. Contrary to the market's exuberant response, a pause in monetary tightening could as easily signal another rise at the next FOMC (Federal Open Market Committee) meeting as the beginning of a new phase of easing. Given a choice between pausing next month and raising rates in September, or doing the same thing in reverse, recent experience dictates that Mr Bernanke should choose the latter.
Copyright The Financial Times Limited 2006
Published: July 21 2006 03:00 | Last updated: July 21 2006 03:00
For the first time in a while, the markets are singing - and with some reason. Ben Bernanke, chairman of the Federal Reserve, this week sketched out a scenario that everyone wants to materialise: a soft landing for the US economy. Having raised rates 17 consecutive times, the Fed's view was that the economy would probably now "expand at a solid and sustainable pace and core inflation should decline from its recent level", he told senators. Given that core US inflation - excluding energy and food - has risen by 0.3 per cent in each of the last four months, Mr Bernanke's assessment was notably upbeat. But the content of his message should not be oversimplified. For good reasons, the probability remains that the Fed will raise rates by another quarter point - to 5.5 per cent - at its next meeting in early August. Only after that is it likely to pause.
The most important question is whether the Fed has done enough in the past two years to squeeze inflation out of the economy. The probability is that it has. And, as the chairman pointed out, some of the effects of recent monetary tightening have yet to feed through. However, there are still material risks to this benign scenario. First, the Fed cannot be sure that inflation expectations - a significant cause in itself of higher prices - have stabilised at their recent lower levels. Second, there are signs of US firms regaining leeway to pass on higher prices to the consumer. Third, nobody can be sure oil prices will stabilise - as the futures market is predicting. Should a barrel of oil advance beyond $90 then all bets would be off. Given the volatile Middle East, this cannot be discounted.
In addition to these risks, Mr Bernanke must weigh two further considerations. First, the price of overshooting on interest rates is lower than undershooting. If the Fed were unnecessarily to raise rates next month again - something that can only be determined in retrospect - it would be a fairly simple matter to undo it later in the year or early next. Conversely, if the Fed kept rates on hold next month only to find that consumer prices were continuing to rise, the cost of correcting this would amount to more than just another quarter point rise.
Second, Mr Bernanke has been plagued by misinterpretation since he took over from Alan Greenspan, the world's most inscrutable public speaker, earlier this year. Specifically, the markets misunderstood what Mr Bernanke meant by an interest rate "pause" when he raised that prospect in April. Contrary to the market's exuberant response, a pause in monetary tightening could as easily signal another rise at the next FOMC (Federal Open Market Committee) meeting as the beginning of a new phase of easing. Given a choice between pausing next month and raising rates in September, or doing the same thing in reverse, recent experience dictates that Mr Bernanke should choose the latter.
posted by Carlos T Mock at 10:13 AM
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