Bernanke to Tell Congress Has Eyes on Growth Risks

WASHINGTON (Reuters) – Housing’s in the tank, banks arescared to lend, but oil is at $100 a barrel and inflation isthreatening to pick up — what’s a central banker to do?

Federal Reserve Chairman Ben Bernanke will deploy his mostreassuring bedside manner in congressional testimony onWednesday and Thursday to explain how the U.S. central bank,which has already cut interest rates 2-1/4 percentage pointssince mid-September, can trim them further to prevent recessionwithout letting inflation get out of hand.

"Near-term, the economy remains extremely vulnerable tofurther contraction because business sentiment has deterioratedfurther and the aggressive Fed easing to date has beenpartially offset by tighter financial conditions," DeutscheBank economists wrote in a note to clients. "This means the Fedis going to have to cut rates further, which is the message Mr.Bernanke will deliver."

Financial markets place a 92 percent chance of a half-pointcut in benchmark rates at the Fed’s next meeting on March 18,as implied by short-term interest-rate futures. Bernanke’stestimony on the central bank’s semiannual report on monetarypolicy and the economy will be closely scrutinized for clues onwhether those bets are on the mark.

INFLATION UNEASE

Worried that financial turmoil would undercut an alreadyweak economy, the Fed chopped rates by three-quarters of apoint in an emergency move on January 22, just eight daysbefore a regularly scheduled meeting.

It lowered them by another half point when its January29-30 meeting wrapped up — a one-two punch that marked one ofthe most aggressive easings of monetary policy in the centralbank’s modern history.

At the same time, policy-makers were taking note of a risein prices that has taken inflation above the ‘comfort zone’ ofa number of Fed officials. Most, however, believed a period ofsluggish growth would draw some inflationary pressure out ofthe system, minutes of the central bank’s last meeting said.

Underscoring the Fed’s dilemma, the Consumer Price Index,released on Wednesday, showed a worrisome 4.3 percent rise inprices in the 12 months through January.

While surging energy and foods costs accounted for much ofthe gain, core prices, which strip out energy and food, were up2.5 percent, the most since last March.

"Rising prices are pinching consumers at exactly the sametime that employment is slowing and the housing market isstruggling," economic consultant Carl Tannenbaum said in aresearch note.

"If growth rebounds quickly after the current soft patch(not altogether unlikely, given the amount of fiscal andmonetary stimulus in the pipeline), the Fed may find itselfhaving to raise rates aggressively later on this year to keepprices under control," Tannenbaum said.

GROWTH FORECAST CUT, INFLATION RAISED

In updated economic forecasts released last week, the U.S.central bank lowered its outlook for 2008 growth by a halfpoint to between 1.3 percent and 2 percent, citing theprolonged housing slump and bottlenecks in credit markets.

However, it also raised projections for both core andoverall inflation, a recognition of the tough environmentofficials face. While the central bank lowers rates to spurgrowth, it would usually raise them to combat inflation.

Bernanke’s commentary this week will be scoured for signsof how the Fed plans to respond to risks to growth, financialinstability, and rising price pressures.

"We have seen deterioration on all three fronts, so the keyto the testimony will be how Bernanke perceives the Fed’s nextmoves in light of ultimately fighting battles on all threefronts," Global Insight economists told clients.

While Bernanke is expected to show the Fed focusedprimarily on downside risks to growth, as he did in testimonyless than two weeks ago, he is also expected to nod to theinflation concerns some officials have begun to highlight.

Dallas Federal Reserve Bank President Richard Fisher, avoter on the Fed’s interest-rate setting committee, said onFriday that while growth could be slower than the central bankexpects, officials needed to be vigilant on inflation risks.

"We have to be mindful of that fact that we have to createthe conditions for employment growth, at the same time becareful that we don’t stir the embers of inflation, and thatrepresents the horns of a dilemma recently," he said.

(Editing by Maureen Bavdek)

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