Federal Reserve Chairman Ben Bernanke issued a rare warning on the risks that a weak dollar poses for inflation, but said U.S. interest rates are "well positioned'' for an economy facing both price pressures and threats to growth.
The downward pressures on the dollar "have contributed to the unwelcome rise in import prices and consumer price inflation," he said.
"We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations."
Bernanke has never put such emphasis on either the Fed's attentiveness to the dollar's decline or the inflationary dangers it poses.
The Fed normally defers to the Treasury on any statements about the U.S. currency, and Bernanke echoed Treasury Secretary Henry Paulson's standard statement that the underlying strengths of the U.S. economy "will be key factors ensuring that the dollar remains a strong and stable currency".
In his prepared remarks, delivered by satellite to the International Monetary Conference in Barcelona, Bernanke left the Fed's economic outlook essentially unchanged and followed other recent Fed officials in signalling no desire for additional rate-cutting.
"We have eased monetary policy substantially and proactively," he said.
Bernanke described it as "well positioned" for now and added it should be "prepared to act as needed."
Bernanke said GDP growth in the first quarter was "apparently positive" and that second quarter "is also likely to be relatively week." He said there "may be somewhat better conditions" in the second half of 2008, because of the combined effects of the Fed"s rate cuts and the fiscal stimulus package.
The risks to growth will be to the downside, from the housing market and oil prices particularly.
Consumer spending has so far "held up a bit better than expected," but they face "significant headwinds" from falling home prices, a softer job market and tighter credit.
Although headline inflation has remained high because of food and energy prices, Bernanke said "the pass-through of high raw materials costs to domestic labor costs and the prices of most other products has been limited, in part because of the softening of domestic demand." If commodity prices just level out, even at high levels, that "would result in a relatively rapid moderation of inflation," and that is what he and other Fed officials are expecting.
The dangers are that commodity prices continue to rise and that persistently high headline inflation "might lead the public to expect higher long-term inflation rates, an expectation that could ultimately be self-confirming." That"s the wage-price spiral which Bernanke said has not appeared so far.
Recent surveys have shown consumers" near-term inflation expectations rising as is common when oil prices are high, but longer-term expectations have not moved up significantly.
Financial markets are broadly better, but "conditions remain strained," Bernanke said.
Balance sheet pressures and the relatively high cost of new capital are constraining bank lending.