Bernanke warns on risks of higher inflation

The fall in the dollar and the rise in the price of oil poses a risk to US inflation, Ben Bernanke told Congress on Thursday, as he explained why the latest Fed statement judged the risks to growth and inflation as roughly balanced.

The Fed chairman said the weak US currency and the higher price of energy would increase headline inflation in the short term and had the potential to boost inflation in the longer run” – though only if inflation expectations became unmoored.”

Bernanke emphasised that the Fed’s base case for inflation was that this would not happen. He said the Federal Open Market Committee projected overall and core inflation to be in a range consistent with price stability next year.”

Inflation expectations appear to be reasonably well anchored” and futures markets suggest that food and energy prices would ease, he said.

The Fed chairman said the strong growth performance of the third quarter was not likely to be sustained in the near term.” He said the Fed had cut interest rates at its last policy meeting because it expected that household spending would grow more slowly” and economic uncertainty could lead business spending to decelerate as well.”

He said the market for nonconforming mortgages remained significantly impaired” and the contraction in housing-related activity seemed likely to intensify.”

Surveys also suggested that banks had tightened terms and standards for a range of credit products, he said.

Mr Bernanke said growth was seen as remaining sluggish during the first part of next year, then strengthening as the effects of tighter credit and the housing correction began to wane.”

But he said there were two important risks to growth. One was that financial market conditions would fail to improve or even worsen, causing credit conditions to become even more restrictive than expected.”

The other was that house prices might weaken more than expected, which could further reduce consumers’ willingness to spend and increase investors concerns about mortgage credit.”

He said the FOMC judged that after its latest rate cut, policy roughly balanced the upside risks to inflation and the downside risks to growth.”

Since the meeting on October 31, he said, economic data releases had continued to suggest that the overall economy remained resilient” in recent months.

But he said financial market volatility and strains have persisted” and new information has intensified investors concerns about credit market developments and the implications of the downturn in the housing market for economic growth.”

In addition, further sharp increases in the price of oil have put renewed upward pressure on inflation and may impose further restraint on economic activity,” Mr Bernanke said.

He said the Fed would continue to carefully assess the implications” of new economic and market data and will act as needed” to foster price stability and maximum sustainable growth.

Charles Schumer, chairman of the joint economic committee, expressed serious doubts about the plan to create a superfund to provide liquidity in the market for asset-backed securities.

He said: ”To be direct, I am worried that this may just be a shell game, an attempt to move bad investments around and keep them from landing on the books.”

Mr Schumer also raised concern about reports ”that foreign investors may no longer be confident in the dollar as the global currency of choice.”

Bernanke warns on risks of higher inflation

Financial Times
11/8/2007 8:55:56 AM