Fed Chief Raises Inflation Concern

By Nell Henderson and Brooke A. Masters
Washington Post Staff Writers
Tuesday, June 6, 2006

Federal Reserve Chairman Ben S. Bernanke expressed more concern about rising inflation than the cooling U.S. economy yesterday, sending his strongest signal yet that interest rates are probably headed higher.

Stocks plunged after Bernanke vowed to combat the recent "unwelcome" pickup in inflation, even as he told an international bankers' conference that an economic slowdown "seems now to be underway."

The combination of high inflation and sluggish growth causes pain throughout an economy: Rising prices reduce the purchasing power of workers' wages, erode savings and diminish the returns on investment. Slow growth pushes up unemployment, squeezes corporate profit and discourages businesses from expanding.

Like many economists, Bernanke argues that keeping inflation low is vital to promoting a strong economy because it allows people to make purchases, borrow money, plan for retirement, invest and make other financial decisions without worrying about rising prices. But beating inflation means raising interest rates, which crimps consumer spending by raising borrowing costs.

"He came right out and said we're worried about inflation," said Arthur Hogan, chief market analyst at Jefferies & Co. "Just what the market didn't need to hear."

Major U.S. stock market indicators fell about 2 percent on the day as Bernanke's comments deflated hopes that the Fed was near the end of two years of steady interest rate increases.

After taking over as Fed chief in February, Bernanke's first public speech was on the importance of low inflation, or "price stability" in central bank jargon. Yet many analysts and investors in financial markets questioned his inflation-fighting credentials in recent weeks, particularly after he told Congress in late April that the Fed might leave interest rates unchanged at an upcoming meeting even if there were risks of higher inflation.

Bernanke's comments yesterday left much less doubt. "He laid down a marker -- that inflation is the primary issue" for the Fed, said David Shulman, a senior economist with the UCLA Anderson Forecast produced by the University of California at Los Angeles Anderson School of Management.

Consumer price inflation has risen this year, largely because of climbing energy prices, Bernanke said. Moreover, he added, measures of "core" inflation, which exclude traditionally volatile food and energy prices, have also moved higher in recent months. The Labor Department's core consumer price index rose at a 3.2 percent annual rate over the past three months and at a 2.8 percent pace over the past six months, he said.

"These are unwelcome developments," Bernanke said, deflating financial market hopes that the central bank would soon stop raising interest rates. Fed officials "will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained."

Many analysts forecast the economy to slow as the housing market cools and dampens consumer spending, which would cause employers to pull back on hiring. That process has begun, Bernanke said.

Still, he did not sound too worried about the economy's health, noting other sources of strength in rising U.S. exports, increased business investment, low unemployment and generally healthy consumer finances.

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