Capital Markets

Bernanke Hints of Higher Rates

Says inverted yield curve does not portend recession; rather it is being caused by "an excess of desired global saving."
Stephen TaubFebruary 15, 2006

Ben Bernanke, the chairman of the Federal Reserve, has hinted that interest rates could rise further in the future, according to published reports.

In his first economic report to Congress, Bernanke, who took over on February 1, agreed with the Fed’s assessment made at its January 31 meeting that interest rates may need to rise some more to keep inflation in check. “The Fed judged that some further firming of monetary policy may be necessary, an assessment with which I concur,” he said, according to the Associated Press.

Bernanke also said the economy is steady, although inflation and other risks remain, said the wire service. And he told the House Financial Services Committee that recent reports on jobs, production, retail sales, and other business activity in January “suggest that the economic expansion remains on track.”

“The risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately — in the absence of countervailing monetary policy action — to further upward pressure on inflation,” Bernanke said, reported Bloomberg.

The chairman also asserted that “the economy now appears to be operating at a relatively high level of resource utilization.” In effect, the economy is operating close to full capacity, and higher interest rates may be needed to keep inflation at bay, noted Reuters.

Bernanke asserted that the future direction of interest rates depends in large part on future reports on the economy and inflation. “In coming quarters, the [Fed] will have to make ongoing, provisional judgments about the risks to both inflation and growth, and monetary policy actions will be increasingly dependent on incoming data,” he stated, added the AP.

Bernanke also said the current inverted yield curve is “not signaling a slowdown” in the economy, even though in the past it often preceded a recession. He said the recent decline in long-term yields — they are now below some short-term rates — resulted from “an excess of desired global saving” in addition to lower perceptions of risk of “unforeseen changes in real interest rates and inflation.”

Like most other experts, Bernanke cites energy prices and the future direction of the housing market as two major challenges to the economy. However, he did not seem too worried about the recently torrid housing market, suggesting he is hopeful it will make a soft landing.

“A leveling out or a modest softening of housing activity seems more likely than a sharp contraction, although uncertainty attends the outlook for home prices and construction,” Bernanke said, according to the AP. “Prices and construction could decelerate more rapidly than currently seems likely.”

He also referred to other economic challenges, including the growing budget deficit and the anticipated future demands on government programs — such as Social Security and Medicare — as Baby Boomers retire. “We have a very serious long-term fiscal problem,” asserted Bernanke, although he would not comment on specific spending or taxation proposals, the AP noted.

Bernanke supports closing a loophole that currently allows companies such as Wal-Mart Stores to own a bank, reported the AP.

Since June 2004, the Fed has raised the benchmark overnight rates to 4.5 percent in 14 different increments. Wall Street expects the Fed to announce another rate raise at its March 27–28 meeting, added Reuters.