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Bernanke Warns of Inflation Risks,
Suggesting No Rate Cut Coming Soon

By GREG IP
November 28, 2006 2:05 p.m.

Federal Reserve Chairman Ben Bernanke said he is still worried about inflation as tight labor markets fuel wage gains, and economic growth outside of housing remains solid.

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WALL STREET JOURNAL VIDEO

Federal Reserve Chairman Ben Bernanke provides an update on the economy, noting "uncomfortably high" core inflation.

Mr. Bernanke's hawkish remarks on inflation and upbeat view of the economy contrast with the emerging view on Wall Street that the economy is weakening and inflation risks have faded. Those views, in recent weeks, had led to rising expectations the Fed will cut rates in the next six months. Bond yields edged higher on Mr. Bernanke's comments though expectations of rate cuts were little changed.

But Mr. Bernanke said the choice facing the Fed at present is whether to raise rates, not cut them. "Whether further policy action against inflation will be required depends on the incoming data," Mr. Bernanke said, echoing the last policy statement released by the interest rate setting Federal Open Market Committee, on Oct. 25.

Addressing the National Italian American Foundation in New York, Mr. Bernanke said that both the economy and inflation had behaved much as expected when he testified on the economy in July. "Outside of the housing and motor-vehicle sectors, economic activity has, on balance, been expanding at a solid pace," he said. While trends in core inflation, which excludes food and energy, are less worrisome than in the spring, at 2.7% in October it "remains uncomfortably high," he said.

While much of the speech reiterated themes of other Fed commentary and his own testimony in July, Mr. Bernanke broke new ground by dwelling on the tight labor market and its potential to push up wages and prices. "It seems clear that labor costs … have been rising more quickly of late," he said. "Some part of this acceleration no doubt reflects the current tightness in labor markets." Furthermore, in another break from recent commentary, he said the fact the economy is operating with less spare capacity has "likely played some role in the rise in core inflation."

The primary reason for his new emphasis on these factors likely relates to the steady decline in the unemployment rate, hitting 4.4% in October. Back in July, Fed officials projected a year-end jobless rate of 4.75% to 5%. At the same time, hourly earnings growth and employment costs has accelerated. Job growth has also been solid, and with it, personal income growth -- the most important determinant of consumer spending. Despite recent worries on Wall Street about a weak start to the holiday shopping season, Mr. Bernanke said that outside housing, consumer spending has been growing at about the same rate through the current quarter that it has since late 2001.

He acknowledged the housing market remains a risk to the economic outlook. "The rate of home-price appreciation has slowed significantly," he noted, and the overhang of unsold homes is likely even larger than the sizable official figures. But he added that home sales seem to be "stabilizing," though construction could continue to decline for a while to bring the supply of unsold homes back in line with demand.

He acknowledged "the correction in the housing market could turn out to be more severe and widespread" than expected. But he also said the economy could rebound from the housing-induced slowdown more briskly than expected. On inflation, "the risks to the forecast seem primarily to the upside. Given the current level of inflation, a failure of inflation to moderate as expected would be especially troublesome."

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