All eyes on Fed over interest rates

Ben Bernanke

NEW YORK - Conflicting economic signals have Wall Street in a tizzy over whether the Federal Reserve should continue raising interest rates, and investors hope Ben Bernanke will shed some light on the matter next week.

The Fed chief is scheduled to participate in a panel discussion in Washington on Monday local time with counterparts from Europe and Japan. Analysts will be parsing his comments for clues into where the man himself stands on the rate debate.

Yet sceptics fear the market might come up empty, again. So far, Bernanke's drive for transparency has actually fuelled greater uncertainty about future policy -- and boosted volatility in the process.

That is because the US central bank itself appears to be on the fence on the need for further monetary policy tightening, so investors' insights into official indecision have done nothing but aggravate their ambivalence.

The trouble, in a nutshell, is this: the US economy is clearly slowing, but inflation has also shown signs of moving above the Fed's range of acceptability.

This creates a conundrum for the Fed, whose mission is to keep the economy expanding at an even keel while avoiding runaway price increases.

Merrill Lynch analysts argue that inflation signals tend to lag behind growth, and caution against putting too much weight into the latest spike in prices.

"We refuse to buy into the big inflation story," said David Rosenberg, chief North American economist at Merrill Lynch. "Inflation is the most lagging of all the lagging indicators." Yet others maintain that the Fed tends to err on the side of caution, and will do its utmost to prevent any budding inflation from getting out of hand.

On the data front, investors will not get much love next week, with the Institute for Supply Management's services sector index the only key release for the bond market.

But the lack of figures will be a welcome respite following a data-packed week that concluded on a positive note for Treasuries, with a weak jobs report on Friday.

The economy generated just 75,000 jobs in May, well below half the median forecast and weak enough to push benchmark 10-year Treasury note yields 0.10 percentage point lower to 5 per cent -- their biggest one-day decline since late 2004.

The report was also the last major reading on jobs before the Fed's next meeting in late June, which would make inflation figures like consumer prices and personal consumption expenditures all the more key to their decision on whether to pause or keep going.

Investors remained split almost down the middle. The latest Reuters poll of US primary dealers showed 12 out of 22 believed the Fed was finished, with the remaining 10 looking for varying degrees of further tightening later in the year.

- REUTERS