Markets rally as Bernanke hints he could halt US rate rises

The chairman of the US Federal Reserve, Ben Bernanke, yesterday dropped a broad hint that interest rates had reached their peak when he predicted that core inflation would cool off over the next year.

US stocks rallied on the news from Mr Bernanke that the US economy was moving to more moderate growth, easing some of the price pressures on the economy. He added that he expected a further decline in inflation in 2008.

"We started from an extraordinary low level, about 1%, and we had to move many times to remove that extraordinary degree of monetary accommodation from the system," he told the Senate banking committee. "We essentially have removed that extraordinary degree of monetary accommodation and we are much more into a normal range of interest rates."

The Dow Jones industrial average rose by 165.46 points on the back of his comments, while the FTSE 100 rose 98.7 points to close at 5778.

The comments were seen as dovish by many analysts as core consumer price inflation yesterday showed a further rise of 0.3% month-on-month, compared with a consensus forecast of 0.2%. "The comments were overall dovish," said Tim Mazanec, foreign exchange director of Investors Bank and Trust Company. "He is trying to suggest that there is some lag effects from the prior 17 rate hikes and they may not have been fully felt in the economy ... he's arguing for a pause." Other analysts were uncertain about whether the Fed would hold rates at 5.25% or increase to 5.5% at the bank's next meeting on August 8. But most agreed that sustained hikes were most likely to come to an end.

"I continue to believe the bear market in bonds is over and that 12 months from now the Fed will be at 5% or lower," said Bill Gross, investment officer at Pacific Investment Management. "Housing is approaching significant declines which will impact the broad economy both in construction as well as consumption."

But despite forecasting slower economic growth and an ease in inflation, the Fed chief warned that the bank would need to be wary of high oil and commodity prices and a tight labour market, which could still pose risks to inflation. "The increase in energy prices and commodity prices certainly has been a significant contributor [to a recent pick-up in inflation]," he said. "Persistently higher inflation would erode the performance of the real economy and would be costly to reverse. The Federal Reserve must take account of these risks in making its policy decisions."

He said Fed officials would need to consider all potential outcomes when deciding the right level for US interest rates.