U.S. Federal Reserve Chairman Ben Bernanke said on Tuesday the credit crisis was not over, even as his colleagues revealed growing concerns about inflation that could signal a pause in interest rate cuts.
"Conditions in financial markets are still far from normal," Bernanke said. "Ultimately, market participants themselves must address the fundamental sources of financial strains. This process is likely to take some time."
A string of other Fed officials in separate speeches seemed increasingly worried that rising energy costs would put upward pressure on inflation, potentially dampening their fervor to cut rates further.
The comments highlighted the Fed's ongoing predicament: It must prevent economic growth from slumping too deeply even as it grapples with price pressures that are largely out of its control.
Bonds sold off sharply following the comments and rate future markets began pricing in strong prospects for higher interest rates by year-end.
Stocks improved on the comments, with the Dow industrials and the benchmark S&P 500 paring losses, while the Nasdaq rose.
'Not Out of the Woods Yet'
Dallas Fed President Richard Fisher spoke to the difficulty faced by the central bank, saying a slower U.S. economy would not necessarily bring down commodity costs.
"There still is growth in the world economy, even if we slow down," Fisher said. "It's difficult for me to see a supply response that will feed into that demand to relieve all the price pressures we see on oil."
Like Bernanke, Fisher noted some improvements in market conditions but said the financial sector was "not out of the woods yet."
Separately, the Cleveland Fed's Sandra Pianalto said that although core U.S. price measures were climbing faster than she wanted, Fed monetary policy was compatible with low inflation.
Oil prices continue to set new records, and were trading above $125 a barrel on Tuesday, after earlier setting another record high near $127.
Such steep increases have have erased at least one full percentage point from U.S. economic growth, according to Thomas Hoenig, president of the Kansas City Fed.
Hoenig said the economy faced a difficult set of circumstances because of high oil prices, the housing downturn and subsequent credit contraction, but growth should pick up later this year.
Fisher, who has dissented against the Fed's more aggressive rate-cutting efforts, said predictions of a very deep recession were misguided.
"I'm not sure how deep the economic slowdown will be," he said at a community event in Midland, Texas, even as he admitted the softness could linger for some time.
A Philadelphia Fed survey of professional economists seemed to counter that optimism, however, finding that the chances of an outright contraction in gross domestic product have risen.
In an attempt to prevent such an outcome, the Fed has slashed interest rates by 3.25 percentage points since mid-September, bringing its benchmark rate to 2.00 percent, and pumped billions of dollars into financial markets to stop them seizing up amid a global credit crunch sparked by the U.S. subprime mortgage crisis.
But the wave of speeches on inflation could signal the Fed's intention to leave rates on hold from here on out, analysts said.
Controversially, the Fed's emergency steps also included a massive cash line that enabled JPMorgan Chase to rescue faltering investment bank Bear Stearns .
Defending the Fed's actions, Bernanke said a Bear Stearns bankruptcy could have touched off a much broader liquidity crisis. Bernanke acknowledged that intervention risked a moral hazard that investors would renew risky behavior in the expectation of being protected by the central bank.
But he said regulation ahead of a crisis was the best way to address that risk.