Falling housing prices and weaker consumer spending are harbingers of an economic deceleration that could drop the growth rate of the gross domestic product as low as 2.5% next year, limiting inflation, Federal Reserve members said when last they met June 29. The estimates, which formed the basis for Chairman Ben Bernanke's comments to Congress on Wednesday, show that members of the Federal Open Market Committee believe core inflation will be 2% to 2.25% in 2007, down as much as three-quarters of a percentage point from 2006. "Contained inflation expectations, the abatement of upward pressure from past increases in energy and other commodity prices and the slowing in the growth of economic activity that was under way were expected to contribute to a moderation in core inflation in coming quarters," the minutes read. The Fed raised rates to 5.25% following the meeting, its 17th quarter-point hike in as many gatherings. Even with the added brake, however, some members worried that inflation might not respond quickly enough. "Participants noted a risk that the drop-back in inflation could be slower or more limited than the committee would find desirable since resource utilization was currently tight and the pickup in price increases had been broadly based rather than being limited to a few specific sectors that could be linked to energy costs," the minutes noted. A majority of the Fed's voting members believe, however, that transitory factors like rising rents and high energy prices caused core inflation to rise in the first part of the year. Both could be solved if the economy slowed down, the members reasoned. "The moderation in the economic expansion was expected to prevent pressures on resource utilization from intensifying," the minutes say. "In sum, with inflation expectations contained and unit labor costs held down by ongoing gains in productivity and modest advances in compensation, inflation was seen by most participants as likely to edge down."
On the key question of whether to raise rates when next they meet Aug. 9, members of the Federal Open Market Committee had yet to make up their minds. As a result, some wanted the policy statement released after the meeting to be short and focus strictly on the goal of limiting inflation. Eventually, members agreed on a statement noting that "although the moderation in the growth of aggregate demand should help to limit inflation pressures over time ... some inflation risks remain." Few if any members appeared to have a firm idea about how the next vote would go. "With the economy slowing and some of the effects of past tightening still in the pipeline, members recognized the value of accumulating more information for determining what, if any, additional policy action would be needed following the tightening adopted at the current meeting. "To indicate that policy action at future meetings was not foreordained and would depend on the forecasts for inflation and activity in the medium term, the committee agreed to state that 'the extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.'"