Federal Reserve Chairman Ben Bernanke expressed confidence on Wednesday in the health of the U.S. economy despite a housing slowdown and said the outlook for inflation was generally benign, but not without risks.
"Overall, the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes," Bernanke said in remarks prepared for delivery to the Senate Banking Committee.
"There are some indications that inflation pressures are beginning to diminish. The monthly data are noisy, however, and it will consequently be some time before we can be confident that underlying inflation is moderating as anticipated," he said, adding that core inflation was "somewhat elevated."
In particular, the central bank chief said it was hard to forecast prices for oils and other commodities, adding: "They remain a key source of uncertainty to the inflation outlook."
Bernanke said the Fed's current policy stance, with benchmark interest rates at 5.25%, was likely to foster sustainable growth and gradually ebbing core inflation.
However, he repeated that the Fed "is prepared to take action to address inflation risks if developments warrant."
Financial markets took their cue from Bernanke's view that inflation pressure were ebbing and prices for U.S. stocks and government bonds rose, while the value of the dollar fell, as traders saw the testimony as suggesting the Fed might be in position to lower interest rates late in the year.
"The market was expecting hawkish remarks, but Bernanke said inflation pressures are beginning to ease," said Lou Brien, market strategist at DRW Trading in Chicago.
Housing Woes Lessening
In its report, the Fed said U.S. gross domestic product was likely to grow by about 2.5% to 3% this year and about 2.75% to 3% in 2008.
Core inflation, as measured by the price index for personal consumption spending minus food and energy, is expected to be 2% to 2.25% this year, and to edge down to a range of 1.75% to 2% in 2008.
Bernanke said the downtrodden U.S. housing market was demonstrating tentative signs of stabilization, but he said that did not mean the economy was now set to roar ahead.
"Even if housing demand falls no further, weakness in residential investment is likely to continue to weigh on economic growth over the next few quarters," he said.
He also said the ultimate extent of the housing market correction was difficult to forecast and warned that it could be greater than the Fed currently expects.
Despite the generally healthy economic environment, Bernanke cautioned that the pace of hiring may prove slower than Americans have come to expect. Anticipated slower job growth could reflect the moderation of economic activity, as well as the impending retirement of the "baby boomers" born after World War Two, he said.
Robust economic activity among major U.S. trade partners is helping to spur a solid expansion in U.S. exports and should continue to do so, the Fed chairman added.
Bernanke said he thought the Fed can do more to open a window into its decision-making process and said that would help to anchor the public's expectations about the Fed's policy course.
He offered no timetable for how soon the Fed might announce any changes in its communications policies, saying only that discussions were continuing and no decisions had been reached.
Bernanke, who wrapped up his first year as Fed chief on Feb. 1, came to the job as an advocate for setting explicit targets for acceptable inflation levels, but it is unclear how far the Fed might move in that direction.