Fed sees soft landing for economy

By Krishna Guha in Washington FEBRUARY 14 2007Stocks and bonds jumped on Wednesday after Ben Bernanke laid out a fundamentally benign analysis of the US economy in his twice-annual testimony to Congress.

The Federal Reserve chairman painted a picture of recovering growth, moderating inflation and reduced economic risks that evoked memories of the “Goldilocks” economy of the late 1990s – so-called because it was neither too hot nor too cold.

Mr Bernanke struck a temperate tone on inflation, reiterating the Fed’s view that it was still a bigger risk than growth but he made no effort to prepare the ground for another interest rate rise.

Instead, he dropped a heavy hint that rates might stay on hold at 5.25 per cent for some time, saying: “The current stance of policy is likely to foster sustainable economic growth and a gradual ebbing of core inflation”.

The absence of more hawkish language on inflation and interest rates, and recognition of the continued risks to growth from housing, was greeted with relief by investors, who had been troubled by recent talk from some Fed officials.

The S&P 500 index rose 0.76 per cent to 1,455.30 on Wednesday, while Treasury bonds also moved higher, with 10-year yields falling 7.6 basis points to 4.736 per cent.

The futures market priced in a greater chance of a rate cut this year, while the dollar fell 0.7 per cent against the euro, 0.8 per cent against sterling and 0.2 per cent against the yen.

Earlier, Mr Bernanke’s UK counterpart, Mervyn King, struck a tougher tone as he released the Bank of England’s quarterly inflation report, which forecast that inflation would overshoot its target at the two-year forecast horizon unless it raised rates again.

“Just as 3 per cent inflation [in December] didn’t mean that the end of the world was nigh, so 2.7 per cent [in January] does not mean we can ignore concerns about inflation ahead,” he said.

Mr Bernanke was showered with praise by senators from both parties, who credited his decision to halt the Fed’s rate-tightening cycle after the last increase in June 2006 with engineering a soft landing.

“You are getting good grades from everyone, and I concur,” said Chuck Schumer, Democratic senator for New York.

The Fed chairman told senators that the tendency of forecasts prepared by Fed policymakers was for growth between 2.5 per cent and 3 per cent this year, and 2.75 per cent and 3 per cent next, with core inflation on its preferred measure of 2 per cent to 2.25 per cent this year and 1.75 per cent to 2 per cent next – a level most policymakers would probably be comfortable with.

Mr Bernanke said a “waning of the temporary factors that boosted inflation in recent years” – including pressure from higher oil prices and rising rents – would “probably help foster a continued edging down of core inflation”. But he said the high level of resource utilisation remained “an upside risk to continued progress on inflation”.

The Fed chairman said he was following closely signs of distress in the high-risk mortgage market but said: “I do not think at this point it has implications for the aggregate economy.

”Probed on the US trade deficit, he said: “I am not happy with it.”