Feb. 28 -- Federal Reserve Chairman Ben S. Bernanke's readiness to cut interest rates to avert a recession is stoking concerns that prices will get out of hand.
``Bernanke has really overweighted the economic risks relative to inflation,'' said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, following the Fed chief's testimony to Congress yesterday. ``He may get some disagreement'' among colleagues on the Federal Open Market Committee, Silvia said.
Investors' expectations for inflation over the next 10 years jumped to the highest since June after Bernanke pledged to the House Financial Services Committee to act in a ``timely manner'' to combat ``downside risks'' to growth. A day after government figures showed wholesale costs rose 7.4 percent in January from a year ago, Bernanke said the price outlook has deteriorated ``slightly.''
Bernanke is at the Senate Banking Committee today in the second day of semiannual testimony on the economy. His prepared remarks were the same as yesterday's.
Senator Richard Shelby of Alabama, the Senate panel's ranking Republican, said he wants to ``make sure'' the Fed ``focuses on the risks associated with increasing inflation,'' citing higher gold, oil and consumer prices.
Fed Dissents
The FOMC last month lowered the benchmark rate by 1.25 percentage points in nine days, the steepest reduction in two decades, to 3 percent. The two decisions each saw one dissenting vote on the Fed panel.
``They will keep cutting,'' said Kurt Karl, chief U.S. economist at Swiss Reinsurance Co. in New York. ``If inflation looks like it is taking off quite rapidly, or inflation expectations take off, they will have to backtrack.''
Rising consumer prices, the ``classic bond worry,'' may start exceeding concerns about the stresses in credit markets, Lehman Brothers Holdings Inc.'s fixed-income strategy team said in a note to clients yesterday. ``We'd nominate the unmooring'' of inflation expectations ``as a prime risk for 2009-2010,'' they wrote.
Representative Gary Miller, a California Republican, told Bernanke that with continued high oil prices, ``it may be more difficult for the Fed to cut interest rates,'' and he asked the Fed chief about his other options besides lowering rates.
``We do face a difficult situation,'' Bernanke acknowledged. Oil and food prices have been climbing ``rapidly,'' and there are ``slightly greater upside risks to the projections'' for inflation now than a month ago.
Biggest Since 1981
Consumer prices last year surged 4.1 percent, the most in 17 years, spurred by higher fuel and food costs. Labor Department figures this week showed the biggest 12-month increase in wholesale costs since 1981 in January.
Ten-year Treasury yields climbed to 3.85 percent yesterday from their January low of 3.29 percent. The notes rallied today as stocks slumped, with yields at 3.79 percent at 7:57 a.m. in New York.
Inflation expectations as measured by the difference in yield between regular 10-year notes and 10-year Treasuries linked to consumer prices reached 2.56 percent after Bernanke spoke, the highest since June. The gauge is now at 2.43 percent.
Barclays Capital Inc. is advising its clients to buy Treasury Inflation Protected Securities, or TIPS.
Buy TIPS
``We don't expect slower growth in the U.S. is going to slow down inflation pressure,'' Michael Pond, an interest-rate strategist at Barclays in New York, said in an interview with Bloomberg Television yesterday.
Consumers' forecasts are also heading up. Households' estimate of price increases one year ahead reached 3.7 percent this month, the highest since August 2006, according to a gauge published by the University of Michigan.
Bernanke told lawmakers the Fed anticipates inflation will slow, in part because of ``sluggish'' economic growth and rising unemployment. In their quarterly forecasts published this month, central bankers projected prices, excluding food and energy, will rise 2 percent to 2.2 percent this year, slowing to a 1.7 percent to 2 percent pace in 2009.
Traders see a 100 percent chance that the FOMC will lower the target rate for overnight loans between banks by at least a half-point, to 2.5 percent. Officials have cut the rate by 2.25 percentage points since September.
``If you move aggressively to cut interest rates and stimulate the economy, then you risk fueling inflation,'' Democratic Representative Greg Meeks of New York said at yesterday's hearing.
`Greater Threat'
Bernanke's testimony came a day after Vice Chairman Donald Kohn said turmoil in credit markets and the possibility of even slower growth pose a ``greater threat'' than inflation.
Unlike recent remarks by other Fed officials and minutes of the last policy meeting, Bernanke made no mention of needing to raise rates once the economy stabilizes.
At the Jan. 29-30 FOMC meeting, some policy makers ``noted that, when prospects for growth had improved, a reversal of a portion of the recent easing actions, possibly even a rapid reversal, might be appropriate.''
Fed Governor Frederic Mishkin, who has collaborated with Bernanke on research, said Feb. 15 the Fed ``should be prepared to take back the insurance'' from rate cuts ``once the recovery becomes clearly established.''
Yesterday, Bernanke reiterated that the Fed's stance ``must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast.''
``He's really telling you that he's going to do what it takes,'' James Caron, global head of interest rate strategy at Morgan Stanley, said in an interview on Bloomberg Television. ``The Fed believes it's a fluent situation, and Bernanke will cut rates as he deems fit.''
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