Federal Reserve Chairman Ben Bernanke is likely to tell Congress this week the central bank is more worried U.S. inflation will flare than it is that housing market turbulence will seriously damage the economy.
Bernanke looks set to emphasize that the Fed's main concern remains the risk that inflation fails to moderate as it expects when he appears before the House of Representatives' Financial Services Committee on Wednesday at 10 am New York time.
He will deliver similar testimony the next day before the Senate Banking Committee. The two days of testimony are part of a twice-yearly ritual in which the Fed chairman presents the central bank's monetary policy report. The report will contain updated forecasts for growth, inflation and unemployment.
While price rises have moderated when volatile food and energy costs are stripped out, Bernanke is expected to stress that core inflation -- which dipped for the third straight month in May to 1.9 percent -- needs to drift a bit lower and stay there for a while before the Fed is satisfied.
"Fed officials believe that holding down inflation is the principal challenge over the next several years, and they are not inclined to tolerate much backsliding after the hard-won improvement in core inflation over the past 12 months," said Roger Kubarych, an economist for UniCredit/Bayerische Hypo-und Vereinsbank in New York.
Inflation-Wariness
Bernanke's testimony will be the first time he has expanded on the terse assessment the Fed offered after its last meeting in June. In a brief statement, it noted improved readings on core inflation, but said sustained moderation in price pressures had yet to be convincingly demonstrated.
Since then, comments from other Fed officials have underscored the central bank's continued inflation-wariness.
San Francisco Federal Reserve Bank President Janet Yellen said on Thursday that recent core inflation readings, while "heartening," could bounce higher. The Fed's tilt toward guarding against inflation rather than bracing for economic weakness is the appropriate policy stance for now, she said.
Fed officials have said that with the unemployment rate hovering around an historically low 4.5 percent, a tight labor market contributes to risks inflation may rekindle.
They have held overnight interest rates at 5.25 percent for more than a year in the hope price pressures would fade amid somewhat sluggish growth, but financial markets see some chance they could lower borrowing costs by year end.
In spite of the Fed's emphasis on core price measures in its policy pronouncements, Bernanke is likely to acknowledge that the economic stress lofty gasoline and food prices have put on Americans is a concern for the Fed.
"We've always thought about food and energy prices. I don't see that as particularly changing," Yellen said.
While Bernanke may nod to the Fed's congressional mandate to maintain stability for overall prices, he and other Fed policy-makers are unlikely to deviate from their view that core price shifts strip away distracting swings and give the Fed a clearer view of where inflation is heading.
Rebound in Economic Growth
Bernanke is also expected to tell lawmakers that in spite of uncertainty about when the struggling U.S. housing market will begin to recover, the economy is on track for modest growth this year and can look forward to a better performance in 2008.
Fed speakers have foreshadowed the view that while housing woes have held back growth, the drag they exert on the economy will wane as the year progresses.
"The consequences of the decline in housing activity and house prices, in my view, have so far not derailed the prospect that economic growth will return toward trend at the end of 2007 and in 2008," Philadelphia Fed President Charles Plosser said on Wednesday.
Economists and Fed officials believe weak growth at the start of the year, exacerbated by a surge in imports and a sell-off in inventories, gave way to a nice rebound in the second quarter. Bernanke is expected to say the economy is set to settle into a more-moderate pace over the rest of the year.
The Fed forecast in February that the economy would expand between 2.5 percent and 3 percent this year, with growth next year in the 2.75 percent to 3 percent range.
Bernanke is also likely to face a grilling from lawmakers upset that the Fed did not do more to prevent lending practices that have led to soaring foreclosures in the subprime mortgage market, which caters to borrowers with shaky credit.