MercoPress. South Atlantic News Agency

Federal Reserve: “some inflation risks remain”

The US Federal Reserve expects inflation to retreat from its recent highs but it could still raise interest rates further (in August) to guard against the risk of a costly inflation surprise, said Fed Chairman Ben Bernanke to Congress on Wednesday.

The forecasts in the Economic Report to Congress show Fed policymakers are willing to tolerate an inflation rate on its core measure of 2% or slightly above this year and next, providing it is heading in the right direction. Fed officials think this approach will allow the economy to grow at close to its trend rate over this year and next.

Financial markets responded enthusiastically to the news. Wall Street shares and bonds rose with the yield on 10 year US Treasuries falling to 5.07%.

Bernanke told members of the Senate Banking Committee: "Our baseline forecast is for moderating inflation". This forecast is largely based on the assumption that a slow-down from above-trend growth is already underway and "should help to limit inflation pressures over time". He also noted that the futures market suggests the price of oil will stabilise, and that profit margins are fat enough to absorb some acceleration in wage increases.

But the Fed chairman cautioned that "some inflation risks remain". He said the combination of high energy prices and high levels of capacity utilization "have the potential to sustain inflationary pressures".

"We must consider not only what appears to be the most likely outcome but also the risks to that outlook and the costs that would be realised should any of those risks be realised", said Mr. Bernanke, which analysts interpret as a suggestion that the Fed may be prepared to raise rates again even though its baseline forecast is reassuring.

"The extent and timing of any additional firming that may be needed to address inflation risks will depend on the evolution of the outlook for both inflation and economic growth''.

The forecasts in the Economic Report to Congress, which reflect the "central tendency" of estimates provided by individual Fed policymakers, show growth of between 3.25 and 3.5% in 2006 and between 3 and 3.25% in 2007, slightly lower than in February.

As to estimates of core inflation, measured by the personal consumption expenditure deflator, the Fed ranged between 2.25 and 2.5% this year and between 2 and 2.25% next year.