It sounds as if the Federal Reserve is giving some serious thought to ending its two-year string of interest rate hikes. Fed Chairman Ben Bernanke's prepared remarks and the accompanying update of the central bank's economic forecast struck a balanced tone. Yes, energy prices and inflation have picked up in recent months. But economic growth is also expected to cool down and productivity growth looks set to keep expanding at a solid pace. Those factors should, from the Fed's perspective, apply some downward force on inflation.
According to the central bank's forecast, the economy will have grown by 3.25% to 3.5% by the end of 2006. The economy already grew at an annual clip of 5.6% in the first quarter and economists expect second-quarter growth of 3%. Given those numbers, the Fed forecast implies growth for the second half of the year in the range of 2.2% to 2.7%.
Housing and consumer spending are expected to be the sources of weakness in the months ahead. Indeed, economists see new and existing home sales slipping some more in June after new home starts data showed builders are scaling back in a significant way.
A weaker housing market won't just impact the economy through reduced residential investment activity. "The slowing of the housing market may restrain other forms of household spending as well," said Bernanke on July 19. Indeed, a weaker housing market combined with deteriorating purchasing power resulting from higher energy prices are likely to weigh on consumer sentiment.
On the plus side, business investment remains strong. Economists within the Fed and on Wall Street expect capital spending to drive economic growth in coming quarters. That's why durable goods orders are expected to have bounced back with a 1.2% increase in June, according to economists polled by Action Economics.
In addition, the second-quarter employment cost index results should affirm that labor costs are growing at a benign pace. That would be good news for the Fed. Modest gains in wages and benefits help fuel consumer spending, but any marked acceleration would spark additional inflation concerns at the Fed. Here's the weekly economic calendar, from Action Economics.