Federal Reserve chairman Ben Bernanke said today that the central bank sees a risk of growing US inflation and would stay on guard against energy-fuelled price pressures.
Bernanke, in the Fed chairman's twice-yearly testimony to Congress, said high energy costs have a potential to feed inflationary pressures. But he also said growth is slowing as the US economy enters a period of 'transition' after years of stellar growth.
'Should that moderation occur as anticipated, it should help to limit inflation pressures over time,' he told the Senate banking committee.
But he warned that although the bank's baseline forecast is for moderating inflation, the Fed's policymaking committee judges that some inflation risks remain.
'In particular, the high prices of energy and other commodities, in conjunction with high levels of resource utilisation that may increase the pricing power of suppliers of goods and services, have the potential to sustain inflation pressures,' Bernanke said.
'More generally, if the pattern of elevated readings on inflation is more protracted or more intense than is currently expected, this higher level of inflation could become embedded in the public's inflation expectations and in price-setting behaviour,' he explained.
'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 added.
The Fed has hiked US interest rates 17 times running but opinion on Wall Street is evenly divided about what action the bank will take at its next meeting on August 8. The fed funds rate is currently at 5.25%.
With oil prices this month hitting new highs above $78 a barrel, some pundits think the Fed will persist with its long-running campaign of rate increases to ward off inflation in the industrial pipeline. But others argue that with signs of slowing economic growth, the Fed would be justified in calling off its campaign for now.
Bernanke said that with appropriate monetary policy and in the absence of major unforeseen developments, 'the US economy should continue to expand at a solid and sustainable pace and core inflation should decline from its recent level over the medium term.'
Mainly because of a cooling housing market, the US economy is set to have slowed from its robust growth pace of 5.6% in the first quarter, the Fed chairman said.
'In particular, consumer spending, which makes up more than two-thirds of aggregate spending, grew rapidly during the first quarter but decelerated during the spring,' he said. 'One likely source of this deceleration was higher energy prices, which have adversely affected the purchasing power of households and weighed on consumer attitudes,' he said.
The Federal Reserve projects that US gross domestic product will grow by 3.25-3.5% this year and by 3-3.25% next year.
Bernanke said that core inflation, as measured by personal consumption expenditures excluding food and energy, would range from 2.25 to 2.5% this year before moderating to 2-2.25% in 2007. Market futures predict that oil prices will stabilise in the coming quarters, he noted.
