In testimony before the House Financial Services Committee Fed Chairman Bernanke told legislators that the economic recovery is not yet on a sustainable path, and that the Fed’s near zero interest rates are still needed. The Fed sees the economy expanding between 3.0% and 3.5% this year and between 3.5% and 4.5% in 2011, but Bernanke noted that the strong growth in the latter half of 2009 was fueled by temporary factors and that the unemployment rate is seen falling only slowly, to around 7% by the end of 2012. Inflation is expected to remain subdued for some time as well, as long-term inflation expectations have remained stable.
On monetary policy, Bernanke reiterated his previous comments that the Fed’s move to raise the discount rate – or the emergency lending rate to banks – doesn’t mean wider borrowing costs for consumers and companies will rise soon as a result. It was a step taken to normalize monetary policy, but not necessarily tighten it. In that regard, Bernanke said the key exit strategy tool will be the interest rate paid on bank reserves.
“By increasing the interest rate on reserves, the Federal Reserve will be able to put significant upward pressure on all short-term interest rates. Actual and prospective increases in short-term interest rates will be reflected in turn in longer-term interest rates and in financial conditions more generally.”
The testimony held little in the way of surprises, and the EUR/USD rose in its wake. That rise likely reflected strength in stocks and risk generally with higher-yielders gaining on the greenback.
