Bernanke gets defensive about the U.S. dollar

WASHINGTON (Reuters) - U.S. Federal Reserve Chairman Ben Bernanke gave an unusually strident defense of the slumping U.S. dollar on Monday, saying he would keep a close watch on its decline and the implications for economic growth and inflation.

In a speech prepared for delivery to the Economic Club of New York, Bernanke also said he expects the economic recovery to continue through 2010, although unemployment will remain painfully high for a while, constraining the pace of growth.

He also offered a couple of caveats on inflation, saying it was subject to a number of "crosscurrents" that could push it higher or lower. Still, he said it was likely to remain subdued for some time, a view that supports the belief the Fed will keep interest rates unusually low for an extended period.

MONITORING THE DOLLAR

* "We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability," Bernanke said.

* Dollar policy is normally seen as the purview of the U.S. Treasury Department, so Fed chairmen typically tread carefully when broaching the subject -- or avoid it altogether.

* Under Bernanke's leadership, this Fed has taken unprecedented steps to combat the deep recession, and there has been concern that the flood of cash into the financial system would weaken the value of the U.S. dollar and trigger inflation.

* The dollar has dropped about 16 percent against a basket of six major currencies since mid-March, when economic worries were running high, sending investors in search of safe havens.

* Bernanke's remarks reflect an acknowledgment of concerns that a steep drop in the value of the dollar could be destabilizing, and also a pledge that the Fed will be vigilant about protecting purchasing power.

* Currency exchange rates are an especially hot topic now with President Barack Obama in China, the largest foreign buyer of U.S. debt. China stands to lose money if the dollar weakens sharply, and has expressed growing concern about that.

* Chinese banking regulator Liu Mingkang said on Sunday the Fed's pledge to hold down borrowing costs and the weak dollar had emerged as a "new systemic risk" because that fueled speculation in overseas asset markets.

WHAT ABOUT THE PACE OF RECOVERY?

* Bernanke said the recent pickup in growth reflects "more than purely temporary factors" and will likely continue next year. The comments were in response to concerns that the recovery was stimulus-driven and would fade once government supports are removed.

* The weak job market and constrained bank lending are "important headwinds" that will prevent the expansion from being as robust as he would hope, he said. That sentiment reinforces the view that Bernanke is in no rush to raise interest rates.

* Before Monday's speech, Bernanke had said little publicly about the state of the economy since September 15, when he said the U.S. recession was "very likely over" although it would probably feel weak for some time and job growth would lag.

CHECKING THE LOW-RATE SIGNPOSTS

* At its last policy-setting meeting earlier this month, the Fed offered a sort of litmus test for when it would begin to normalize interest rates, which are now near zero. It said low rates of resource utilization, subdued inflation trends, and stable inflation expectations would warrant exceptionally low rates for an extended period.

* Bernanke repeated that phrase, but pointed out that changes in economic conditions and the outlook would change the outlook for policy as well.

* He said it was hard to accurately measure how much slack there is in the economy, a nod to some Fed officials who have publicly questioned whether policy-makers were putting too much faith in the so-called output gap.

* He also mentioned rising commodity prices, which he said reflected a pickup in global economic activity as well as the weakening dollar. But he concluded that inflation "seems likely to remain subdued for some time."