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U.S. economy headed for stomach-churning rest of the year

The Wall Street Journal Home Page

Bernanke Foresees More Pain

Testimony Suggests 
That Rate Increase 
Isn’t in the Cards
By SUDEEP REDDY and ANTON TROIANOVSKI
July 16, 2008; Page A3

With producer prices rising at the fastest pace in 27 years and Federal Reserve Chairman Ben Bernanke giving one of his gloomiest reports on growth, the U.S. economy is headed for a stomach-churning rest of the year.

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Financial turmoil and high oil prices appear to be driving down consumer demand. Retail sales rose just 0.1% in June over the previous month, and were down 0.5% when gas-station sales were excluded, the Commerce Department reported Tuesday.

Mr. Bernanke, testifying before the Senate Banking Committee, warned that both the growth and inflation pictures are facing serious risks.

“The possibility of higher energy prices, tighter credit conditions and a still-deeper contraction in housing markets all represent significant downside risks to the outlook for growth,” Mr. Bernanke said in his semiannual report on monetary policy. At the same time, he said, “upside risks to the inflation outlook have intensified lately” because of higher commodity prices.

Mr. Bernanke’s comments reinforced views that the central bank is unlikely to raise its benchmark rate from the current 2% anytime soon.

Concerns about mortgage giants Fannie Mae and Freddie Mac have fueled uncertainty. The Dow Jones Industrial Average on Tuesday fell 92.65 points, or 0.8%, to 10962.54, its first close below 11000 since July 2006. Despite new support from the federal government, announced Sunday, Fannie and Freddie shares continued to decline sharply.

The Treasury Department is seeking the authority to spend public funds backing the two companies. “Healthy economic growth depends on well-functioning financial markets,” said Mr. Bernanke. “Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve.”

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Oil futures fell $6.44 to $138.74 on concerns about economic weakness. A new report from the Organization of Petroleum Exporting Countries said demand for oil will be less than expected. The dollar dropped to a record low against the euro at one point early Tuesday before recovering somewhat.

Bankers say the problem of defaults, once limited mainly to high-risk mortgages, has spread more widely. First Horizon National Corp., a Memphis, Tenn., lender that lost about $19 million in the second quarter, said it was bracing for higher defaults on commercial loans. Its chief executive became the latest bank executive to lose his job.

Some consumer borrowers, squeezed by soaring prices for gas and necessities, are falling behind on their mortgage and credit-card payments. “We are seeing it more and more,” said Richard Moore, president of Peoples Southern Bank in Clanton, Ala. “Two or three months ago it wasn’t as much of a pressure as it is now.”

The economy’s woes prompted politicians to try to reassure the public. President George W. Bush told reporters the American banking system “basically is sound.” House Democrats floated plans Tuesday for a second economic-stimulus bill of perhaps $50 billion or more. The legislation isn’t expected to come up in the House until September.

At the hearing, Mr. Bernanke said it would take “a bit more time” to gauge whether additional economic stimulus is needed. However, he stressed that legislation to address the housing downturn would be valuable. Uncertainty about housing “is creating financial stress, it’s affecting consumer wealth and consumer expectations, and is causing the stress we’re seeing in the economy,” he said.

Most Fed officials in June projected the economy would grow 1% to 1.6% this year, up from projections of 0.3% to 1.2% at their meeting in April. But they indicated “considerable uncertainty” for their growth outlook and “viewed the risks to their forecasts as skewed to the downside,” Mr. Bernanke said.

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Retail sales rose just 0.1% in June. Financial travails and oil prices appear to be weighing on shoppers.

Fed policy makers projected the overall inflation rate — as measured by the price index for personal consumption expenditures — at 3.8% to 4.2% this year, up from 3.1% to 3.4% in their April forecast. Core inflation — excluding food and energy — is expected to be 2.2% to 2.4% this year, unchanged from the April estimate.

Mr. Bernanke repeated that officials are watching whether “inflationary impulses” are becoming embedded in the setting of wages and prices. That doesn’t appear to be happening so far. He said the effect of high commodity prices on most finished goods, other than food and energy, “seems thus far to have been limited.” But he warned that business may try to pass through their costs more aggressively.

Companies are already struggling with higher prices. Producer prices rose a seasonally adjusted 1.8% in June and soared 9.2% from a year ago, the biggest year-over-year increase since 1981, the Commerce Department said. The core index, which excludes food and energy, rose 0.2% and was up 3% from the year before.

Lehman Roberts Co., a highway contractor in Memphis, is now paying about $650 for a ton of asphalt, more than twice as much as it paid late last year. The company is trying to renegotiate some fixed-price contracts with private customers. “We just have to go back to them hat in hand and tell them the cheese moved on us,” said Patrick Nelson, Lehman Roberts’s vice president.

Some firms are revamping their strategy in the face of high commodity prices. Newell RubbermaidChief Executive Mark Ketchum on Tuesday announced that the company would stop producing many of its signature products “in light of the raw material hyperinflation we are experiencing.” Rubbermaid, a maker of garbage pails, rubber tubs, and office supplies, has been hit hard by the rising price of resin.

The Commerce Department retail-sales data, showing a decline in sales excluding gas stations, suggested that tax-rebate checks have provided a shorter-lived boost to retailers than many economists had expected. The government has sent at least $91 billion in stimulus payments to U.S. households since the checks began going out in April, and the last of the Treasury’s mass disbursements are being mailed this week.

Annette Johnson, who gives her age as “50-plus” and lives in the Washington area, spent five years as a hotel sales manager before she was laid off in February. She hasn’t been able to find a job since. “It leaves you little hope as to what’s going to happen in the future,” Ms. Johnson said, citing the housing market and high food and fuel prices. “You can’t really depend on family members because everyone’s struggling themselves.”

–David Enrich and Joanna Slater contributed to this article.

Write to Sudeep Reddy at [email protected]

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