Fed Chief Raises Inflation Concern

Fed economists have expected consumer prices to rise temporarily this year, as businesses pass on some of their higher costs for energy, metals and other raw materials. But Bernanke expressed concern that inflation might persist at an unacceptably high level, particularly if it causes businesses and consumers to expect bigger price increases.

Fed policymakers "must continue to resist any tendency for increases in energy and commodity prices to become permanently embedded in core inflation," Bernanke said.

Before his warning, many investors believed there was a 50-50 chance the Fed might leave its benchmark short-term rate unchanged at its policymaking meeting June 28-29, taking a pause after two years of steady increases. After his remarks, futures markets traders boosted their bets that Fed officials will increase the rate to at least 5.25 percent from 5 percent, for a 17th consecutive increase.

"The markets see [interest] rates going up and staying high for a while," while the economy slows and profits get squeezed, Shulman said.

The Standard & Poor's 500-stock index fell 1.8 percent, its steepest one-day drop since January. The Dow Jones industrial average dropped 1.8 percent, to its lowest level since early March. The Nasdaq composite index shed 2.2 percent, erasing any gain this year. Meanwhile, oil closed at more than $72 a barrel yesterday after Iran's leader threatened to reduce production in response to Western pressure to curtail that nation's nuclear technology program.

Global financial markets have been volatile for more than a month, largely because of uncertainty about inflation, interest rates, oil prices and the pace of U.S. economic growth.

The markets' reaction yesterday reversed the gains recorded Friday, when a weak labor-market report encouraged many investors to think the Fed would not raise interest rates this month for fear of "overshooting," or raising rates too high and triggering a sharper economic slump.

But, Bernanke said, a single economic report, such as one month's employment figures, would not by itself change the Fed's interest rate policy. Rather, because interest rate changes take effect over many months, the Fed would study how such a report affects its forecast for the economy six to 12 months down the road.

"He seemed to have greater concern for inflation than a slowing economy," said Stephen Massoca, co-chief executive of the boutique investment bank Pacific Growth Equities LLC.