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Ben S. Bernanke testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate

Fri, Feb 15 2008, 09:20 GMT
by Luis Arregoces

BBVA Bancomer

• • Bernanke indicated that downside risks to growth have increased and conditions in the labor market have softened
  
• • Bernanke’s baseline outlook involves a period of sluggish growth in the first half of 2008
  
• • The speech is consistent with our current expectations of a 0-25 bp cut in the next FOMC meeting
  

The Fed Chairman’s speech did not change drastically from his previous intervention in front of the House of Representatives budget committee last month. The market was expecting a more “dovish” speech; however, Mr. Bernanke hinted that the Fed focuses on the intermediate-term rather than the short-term, which is more consistent with a pause rather than another rate cut in the next meeting.

In addition, there was no reference to a possible U.S. recession, but the Fed’s “baseline outlook involves a period of sluggish growth” in the first half of 2008. Bernanke acknowledges that softness in labor markets combined with inflation risks could interfere with the already difficult task of balancing growth and price stability in an environment of financial turmoil and “restricted” access to credit for many firms and households.

His statement regarding current information points out to a worsening in the economic outlook for 2008 and increasing downside risks to growth. In addition, strains in financial markets remain, and some banks have reported large losses. Bernanke stated, once again, that the Fed is willing to "act in a timely manner as needed to support growth and to provide adequate insurance against downside risks."

The risk of inflation is present; nevertheless, to date, inflation expectations appear well anchored. Also, the Fed recognized the fast pace of food prices and energy prices in 2007 as well as the recent increase in core price inflation. In addition, Bernanke stated that the Fed is monitoring closely all the developments in the economy to “properly calibrate” monetary policy and asses the effects of previously taken policy actions.

Bottom line. Bernanke speech suggests that the Fed is lowering its economic growth forecast, as it considers a slower pace of job creation and the ongoing housing adjustment. As a result, downside risks to growth continue increasing and are further augmented by strains in financial markets. In addition, inflation concerns remain relatively contained. By recognizing the lagged effects of monetary policy, Bernanke could be signaling that aggressive policy actions such as those taken in recent weeks should not be expected if economic conditions improve. However, if economic indicators continue deteriorating, the Fed will continue lowering interest rates.

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Published on  Fri, Feb 15 2008, 09:27 GMT