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Bernanke’s signal for rate cut stokes fears of inflation

Investors worry that stagflation could hit the US but Fed chief rejects the notion

WASHINGTON – UNITED States Federal Reserve chairman Ben Bernanke’s readiness to cut interest rates to avert a recession is stoking concerns that prices will get out of hand.

‘Mr Bernanke has really overweighted the economic risks relative to inflation,’ said Mr John Silvia, chief economist at Wachovia, following the Fed chief’s second and final day of testimony to Congress on Thursday.

‘He may get some disagreement’ among colleagues on the Federal Open Market Committee, Mr Silvia said.

Investors’ expectations for inflation over the next 10 years jumped to the highest since last June after Mr Bernanke said the US central bank will act in a ‘timely manner’ to combat ‘downside risks’ to growth – a signal to investors that the Fed will again cut interest rates.

The hope is that lower interest rates will encourage consumers and businesses to spend more, while the risk is that the weaker US dollar that will result from lower rates will cause prices of goods and services to be adjusted upwards. A falling US dollar has also seen investors put more of their money into commodities, driving up the prices of oil, metals and food.

Fears have grown that the US could come under the grip of stagflation, when stagnant growth is combined with rising inflation, for the first time in decades.

Mr Bernanke rejected the notion.

‘I don’t anticipate stagflation,’ he told lawmakers. ‘I don’t think we’re anywhere near the situation that prevailed in the 1970s.’

Mr Bernanke added that he expects inflation to calm down, in part because of sluggish economic growth and rising unemployment.

For now, he said, the biggest risk is the weakening economy.

Traders now see a 100 per cent chance that the Fed will lower its target rate for overnight loans between banks by at least a halfpoint, to 2.5 per cent at its next meeting on March 18.

Mr Bernanke acknowledged that with oil prices hitting all- time highs and food prices rising, the Fed was ‘in a difficult situation’.

‘While we can’t do much about oil prices or food prices in the short run, we do have to be careful to make sure that those prices do not either feed substantially into other types of prices,’ he said, adding that the Fed must ensure that the public stays ‘confident’ that it will control inflation.

Consumer prices last year surged 4.1 per cent, the most in 17 years, while wholesale prices were up 7.1 per cent, the biggest 12-month increase since 1981.

And consumers are expecting prices to keep on rising. Households’ estimate of price increases one year ahead reached 3.7 per cent last month, the highest since August 2006, according to a poll by the University of Michigan.

Source: BLOOMBERG NEWS, ASSOCIATED PRESS (The Straits Times 1 Mar 08)


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