Bernanke sees economy in ‘transition’

updated 8:48 a.m. ET June 6, 2006

WASHINGTON - Federal Reserve Chairman Ben Bernanke is promising that the central bank will remain vigilant in fighting inflation. The comments sent shock waves through financial markets hoping the Fed was about to call a cease-fire on interest rate increases.

Instead, Bernanke’s comments are likely to mean further increases in borrowing costs for consumers on their home and auto loans and credit card debt and for small businesses trying to raise money at their local bank.

The comments to an international monetary conference on Monday were exactly the opposite of what Wall Street was expecting.

Investors had grown hopeful that a slew of slower-than-anticipated economic reports, including a shockingly small 75,000 job increase last month, would persuade the Fed to call a halt to further rate increases.

While acknowledging in his comments that economic growth did appear to be slowing, Bernanke chose to also emphasize a number of troubling developments regarding inflation.

He noted in particular that core inflation, excluding energy and food, was rising at an annual rate of 3.2 percent by one inflation gauge and 3 percent by another.

“These are unwelcome developments,” he said.

Bernanke said that the Fed “will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained.”

That was all Wall Street investors needed to hear on Monday to trigger a stock sell-off that pushed the Dow Jones industrial average down by 199.15 points, or 1.77 percent, the biggest one-day sell-off since the Dow sank by 214 points on May 17, the day the government released a report on consumer prices that showed a worrisome uptick in inflation pressures.

Stock markets in Asia and Europe followed suit on Tuesday. In Tokyo, the benchmark Nikkei 225 index dropped 1.81 percent, while India’s benchmark Sensex index fell 2.5 percent. In Europe, London’s key index, the FTSE 100, fell more than 1 percent by early afternoon, while key stock indexes were down almost 1 percent in Frankfurt, Germany, and 1.4 percent in Paris.

Bernanke “provided an emphatic commitment to maintaining price stability that suggests to me that he will be pushing for another tightening at the end of the month,” said Stephen Stanley, chief economist at RBS Greenwich Capital.

Economists had been hoping that the Fed, which had pushed a key rate up for a 16th consecutive time in May, would take a pause at the Fed’s June 28-29 meeting.

However, many analysts now believe that not only is a pause in June off the table, but that the Fed might decide to keep pushing rates higher at the August meeting as well.

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