Inflación en EEUU, TWSJ.

At Fed, Inflation Is Top Worry,
Making Rate Cuts Unlikely
By GREG IP
July 19, 2007; Page A1

WASHINGTON -- Don't expect interest-rate cuts anytime soon.

That was Federal Reserve Chairman Ben Bernanke's message when he testified before Congress yesterday. The nation's underlying inflation rate has dropped and the housing slump has deepened, but inflation remains the Fed's biggest worry.

"Upside risks to inflation are [the Fed's] predominant policy concern," the Fed chief told lawmakers.

Core inflation has dropped, and Federal Reserve Chairman Ben Bernanke doesn't see a crisis in the future, interprets WSJ's Greg Ip.
Mr. Bernanke added a new inflation risk to the ones he has cited in the past: Productivity growth has "slowed somewhat," he said.

Slower productivity growth means it takes companies more labor to produce an additional unit of output. That raises their production costs and makes them more likely to raise prices.

Though expected, the hawkish tone of Mr. Bernanke's remarks unnerved investors, and helped to send the Dow Jones Industrial Average down 53.33 points to 13918.22. Treasury-bond prices rose, however, pushing their yields down; the 10-year note finished at 96 3/32, up 17/32, to yield 5.009%.

Since February, core inflation, which excludes food and energy prices, has slowed to about 2%. But forecasts released in connection with Mr. Bernanke's testimony yesterday before the House Financial Services Committee showed that he and his Fed colleagues think inflation will edge higher over the remainder of 2007.

"Month-to-month movements in inflation are subject to considerable noise, and some of the recent improvement could also be the result of transitory influences," Mr. Bernanke said.

The Fed chief implicitly responded to criticism that, by focusing on core inflation, the Fed has underplayed the inflationary consequences of rising food and energy prices. "Sizable increases in food and energy prices have boosted overall inflation...in recent months," to a level that "would clearly be inconsistent with the objective of price stability," he acknowledged. But as long as commodity and energy prices flatten out, as futures markets anticipate, then "overall inflation should slow to a pace close to that of core inflation in coming quarters," he said.

Mr. Bernanke's basic outlook appears to have changed little, despite his hawkish words. He and his colleagues believe that despite the risks, core inflation will end 2008 between 1.75% and 2%, the same as they forecast in February, in part because higher food and energy prices have yet to cause consumers' expectations of inflation to increase.

June inflation data released yesterday provided some support for the Fed's cautious stance. The consumer-price index in June was up 0.19% from May as rising food costs offset a decline in energy prices. Consumer prices in June were up 2.7% from a year earlier, the same as in May.

The core CPI rose 0.23%, its biggest monthly advance since February, as tobacco and hotel costs jumped. Apparel prices continued to fall. Core consumer prices last month were up 2.2% from a year earlier, unchanged from May.

Worsening Problems

He acknowledged worsening problems in the housing market, which led Fed officials to trim growth forecasts for both this year and next compared with their February outlook. But Mr. Bernanke was generally sanguine about the economy. "Declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time," he said.

Yesterday, the Commerce Department said housing starts in June increased 2.3% from May to an annual rate of 1.467 million units, but May's starts were revised downward. It also said building permits, which are less volatile than starts, fell 7.5% to a 1.406 million annual rate in June, more than reversing a 4.3% gain in May.

Despite having to mark down its outlook for housing, the Fed continues to see less risk to the overall economy than many investors fear. One reason is that delinquencies have risen sharply principally on only one class of home loans: adjustable-rate subprime mortgages.

Indeed, Mr. Bernanke told Congress the problem is mostly confined to mortgages taken out in late 2005 and 2006 when a confluence of rising home prices and Wall Street demand for high-yield securities led to a disastrous decline in underwriting standards. Delinquencies on prime and fixed-rate subprime mortgages remain low. Subprime mortgages are home loans made to borrowers with sketchy credit histories. (Some analysts note that delinquencies on "alt-A" mortgages, which are between prime and subprime, are also rising.)

MORE ON THE FED

• Text of Bernanke's testimony
• Fed 2007 Monetary Policy Report
• Real Time Economics: Latest news and analysis of the economy
• Major Themes: Bernanke on inflation, housing, regulation, more.Mr. Bernanke acknowledged that in recent weeks, interest rates on lower-quality corporate bonds and bank loans have risen relative to safer investments. But, he added, those spreads "remain near the low end of their historical ranges."

Another reason for the Fed's equanimity is that it sees the downturn in housing as necessary to restore balance to the market. "This is a process that is going to have to work its way out," Mr. Bernanke told one congressman, noting that even after recent declines, housing activity has only returned to where it was in the late 1990s.

New Risk

Perhaps the most important new risk Mr. Bernanke cited yesterday was slowing productivity growth. Productivity growth slowed to an annual rate of 1% in the first quarter from 2% in the preceding two years and even higher rates before that. Fed officials have wondered whether this reflected short-term hoarding of workers by companies hit with slower sales, or some more structural change. Mr. Bernanke now believes it is a bit of both. He also appeared to play down another explanation: that productivity data are distorted downward by overstated estimates of construction employment.

Slower structural productivity growth means achieving a given increase in economic output requires more workers than before. That implies "a more inflation-prone economy, as demonstrated by the still-tight labor market even as the economy has slowed," wrote Peter Kretzmer, economist at Bank of America, in a research note.

One clue that the Fed is more pessimistic on productivity growth is that officials lowered their forecasts for economic growth both this year and next by a quarter percentage point from their February view, with little change in their unemployment forecast. Such interpretations must be taken with caution, however, because the forecast is the result of polling 17 policy makers, some of whom don't rely on a fixed relationship between productivity, inflation and growth when making forecasts.

Write to Greg Ip at greg.ip@wsj.com