By Martin Wolk Executive business editor
msnbc.com
updated 7/20/2006 11:17:54 AM ET 2006-07-20T15:17:54

Federal Reserve Chairman Ben Bernanke seems to be speaking a language that Wall Street likes to hear — at least for now.

Major Market Indices

Bernanke testified on Capitol Hill for the fifth time in five months Wednesday and sparked a major rally in the battered stock market by suggesting he is confident the cooling economy will keep a lid on simmering inflation.

Bernanke was careful to stress that the economy still faces risks both from the possibility of sharply slower growth and from inflation that is still accelerating. So his comments did not clearly indicate whether the Fed will raise rates for an 18th consecutive time when policy-makers hold their next scheduled meeting Aug. 8.

But by coming down firmly in the middle, he injected a welcome dose of uncertainty into the outcome and heartened investors who have grown nervous the Fed might continue tightening into the teeth of an economic slowdown and sharply rising oil prices.

Wachovia economist Mark Vitner said there is "still better than a 50 percent chance" that the Fed will hike its overnight lending rate another quarter-percentage point, to 5.5 percent in August.

"But now the consensus is that it is not a sure thing they are going to raise rates, and if they do there is a very good chance it will be the last move," Vitner said.

The Fed has been steadily raising interest rates for more than two years, pushing up borrowing costs for consumers and businesses in an effort to keep a lid on growth and stay ahead of inflation. But now inflation is beginning to bubble up above the Fed's comfort level, even as the economy shows clear signs of slowing.

Both risks were clearly in evidence Wednesday as the government reported that consumer prices, excluding the volatile food and energy categories, rose 0.3 percent last month and are up 2.6 percent over year-ago levels, well above the Fed's presumed 2 percent target.

Meanwhile housing starts fell a sharper-than-expected 5.3 percent in the latest sign that the housing sector, which has buoyed consumers and the economy for years, is well into a downturn.

The plain-spoken Bernanke, who has roiled markets in the past with his direct approach, said the economy is in a "period of transition" that demands caution.

“There are risks in both directions, if I may say so,” Bernanke told the Senate Banking Committee. “Clearly we don’t want to tighten too much to cause our economy to grow more slowly than its potential. We are very aware of that concern. We think about it. We look at it. We try to evaluate it."

Hugh Johnson, chairman of Johnson Illington Advisors, applauded  what he called Bernanke's flexible approach.

"It's clear that he isn't advocating some sort of monomaniacal or singular focus on inflation," Johnson said. "That is very good news. Monetary policy is going to be responsive to both  economic conditions and inflation concerns."

Bernanke came into office as an advocate of publicly setting a Federal reserve inflation "target" that monetary policy-makers would try to attain through raising and lowering rates. Bernanke's predecessor, Alan Greenspan, opposed such a target in favor of a more flexible, ad-hoc approach to policy.

And Bernanke's initial public speeches and appearances as Fed chief did little to sooth concerns that the former Princeton professor was "doctrinaire" in approach. In June Bernanke sent markets tumbling by plainly signaling the Fed's intention to hike interest rates even after a particularly weak employment report.

The Fed chief also made a rookie error by making an offhand remark to a CNBC reporter who then repeated it on the air and turned it into a market-moving event.

But Wednesday's balanced rhetoric made a believer out of many investors, including Johnson.

"He is now as flexible as Greenspan but even more articulate in building the case for enlightened, balanced and responsive monetary policy," Johnson said.

Still, some analyst said the warm feelings toward Bernanke might not last long, especially if another rate hike sends the volatile stock market reeling again.

here was a sense that and  is slowing  .prevent inflation from an , dating to mid-4 when rates were at their lowest level in 46 years. ."

Economist Joel Naroff of Naroff Economic Advisers said Bernanke's forecast of steady growth and slowing inflation is a "Goldilocks" forecast of a "just-right" economy.

With inflation steadily rising rising and oil now above $74 a barrel, "I just find it a little difficult to believe," Naroff said. "I hope it is indeed what turns out to be the case, but if I was an investor and I saw somebody forecast economic Nirvana, I would be a little bit cautious."

Ethan Harris, chief U.S. economist at Lehman Bros., agreed the inflation is likely to prove harder to extinguish than many people would prefer. He predicts central bankers will feel compelled to raise rates in August and again in October.

"The markets have had a nice celebratory rally today," Harris said. "But if the Fed now goes and hikes, he is going to get a new bout of market complaints. I don’t think there is any way he can win here in this situation."

"It's not over yet, this Bernanke bashing."

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