Bernanke to say economy sound, inflation a risk

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke looks set to tell Congress this week that the U.S. economy is sound, but that the central bank is still concerned that inflation, while moderating, may not fully come to heel.

In two days of testimony on the Fed’s semiannual monetary policy report on Wednesday and Thursday, Bernanke can boast that the central bank’s interest-rate strategy appears to have put the economy on track for a “soft landing” in which growth slows just enough to keep inflation at bay.

At the same time, he will caution lawmakers -- and financial markets -- that a low-inflation outcome is not yet assured, and that the central bank stands ready to raise benchmark interest rates above their current 5.25 percent level to squelch bubbling price pressures if necessary.

The Fed has held overnight borrowing costs steady since June, when it put in place the last of 17 straight rate increases.

After their last meeting on January 30-31, Bernanke and his colleagues indicated concern that a tight labor market might make it difficult to bring inflation down. The U.S. jobless rate stood at a historically low 4.6 percent in January.

“With the low unemployment rate, he remains concerned that core inflation might pick up again after having slowed a bit recently,” said Maury Harris, chief U.S. economist for UBS in New York.


When he appears before the Senate Banking Committee on Wednesday and the House of Representatives’ Financial Services panel on Thursday, Bernanke will be able to tell lawmakers that the worst is probably over for the U.S. housing market, which took a big tumble in 2006 after a multiyear boom.

He can also note that inflation, which perked up to levels that made the central bank nervous last year, has moved down and is likely to continue to moderate as the economy grows at a pace slightly below its long-term speed limit.

The economy expanded at an unexpectedly swift 3.5 percent annual clip in the closing quarter of 2006 despite the housing slump. However, core inflation moved ahead at just a 2.1 percent pace, down from 2.2 percent in the third quarter.

Supporting the outlook for steady growth, data show that inventories of unsold homes are beginning to thin and that resilient U.S. consumers continue to spend.

“Bernanke can be expected to provide an upbeat assessment of economic conditions,” said Mickey Levy, chief economist at Bank of America in New York. “Bernanke will represent the views of the Fed that the economy will grow close to trend, and that the probability of a downturn is small.


As always, the Fed chief’s testimony will be closely parsed by financial markets looking for clues on where interest rates are heading.

When the Fed stepped to the sidelines last year, some analysts felt policy makers had not raised credit costs enough to thwart inflation. Later, as the depth of the housing downturn became clear, markets began to fear the Fed had gone too far and would have to change course early in 2007.

Now, however, the Fed is expected to hold rates steady at least until mid-year.

“In hindsight, the Fed’s policy pause last summer was perfectly timed,” said Ethan Harris, chief U.S. economist at Lehman Brothers in New York. “The Fed’s forecasts for both growth and inflation have been right on target.”

Facing Democratic committee chairmen for the first time, Bernanke is likely to try to reassure them that stating an explicit target for inflation -- something Fed officials have been considering -- would never overshadow the central bank’s other task of aiming for full employment.

Some Democratic lawmakers, including the chairman of the House panel, Barney Frank of Massachusetts, worry a numeric inflation target might denigrate the full employment goal.

Bernanke may also discuss whether the Fed will offer a more frequent look at its forecasts or whether it might even make its staff forecasts public as part of an initiative he has launched to offer the public and financial markets a clearer window into the central bank’s thinking.