- The Washington Times - Monday, June 5, 2006

Federal Reserve Chairman Ben S. Bernanke yesterday signaled more interest-rate increases are likely because underlying inflation has spiked to “unwelcome” levels, touching off a nearly 200-point drop in the Dow Jones Industrial Average.

Mr. Bernanke’s remarks before a gathering of international bankers here came as oil prices surged on a threat from Iran’s supreme leader to withhold energy supplies if the United States attempts to punish the Middle Eastern oil producer for pursuing nuclear research — a development that also troubled the markets because it adds to inflation and weakens economic growth.

Mr. Bernanke blamed high energy prices for zapping consumer spending and confidence this year as well as pushing the underlying, or “core,” level of inflation above levels that the Fed will tolerate. Core inflation, which excludes energy prices but reflects moves to pass on higher energy costs by businesses, has been running between 2.3 percent and 3.2 percent, he said, above the Fed’s 1 percent to 2 percent “comfort zone.”

“These are unwelcome developments,” he said. The Fed’s rate-setting committee “will be vigilant to ensure that the recent pattern of elevated monthly core-inflation readings is not sustained.”

The economy is in a transition to substantially slower growth under the weight of four percentage points of interest-rate increases the Fed has ordered in 16 actions in the past two years, Mr. Bernanke said. The economy from now on should grow no faster than its average potential growth rate — estimated at about 2.5 percent to 3 percent — to ensure that inflation does not get out of hand, he said.

His remarks caused markets to plunge not only at the prospect of higher rates but also on fears that the Fed may go too far and induce a severe slowdown or recession by raising rates too much. Mr. Bernanke has proven to be far more hawkish on inflation than Wall Street expected when he took office in February, and his remarks yesterday were among his toughest yet on the need to stamp out the inflation threat.

Stocks plunged across the board, with the Dow falling 199 points to end at 11,049, and other major indexes posting declines in the 2-percent range. Market interest rates and the dollar rose in anticipation of higher short-term rates, retracing declines they posted Friday when a report showing weak job growth convinced many on Wall Street that the Fed would pause at its next meeting June 29 and not raise rates.

Mr. Bernanke noted that job gains have tailed off this year and said that was “consistent with the softening in the pace of overall economic activity that seems to be under way.” He added that the low unemployment rate of 4.6 percent, however, suggests that wage growth that so far has been subdued could start to pick up and add to inflation pressures.

“He’s telling you inflation concerns are tipping the scale toward raising rates,” said Raymond Remy, head of fixed income at Daiwa Securities America Inc.

Mr. Bernanke held out hope that inflation pressures will ease later this year if oil prices come down — a possibility that seemed remote yesterday as worries about the nuclear standoff between Iran and the United States continued to roil the markets. By some estimates, the Iran affair has added $15 to the price of premium crude, which landed at $72.31 a barrel at the end of New York trading yesterday.

As yesterday’s developments showed, the Fed has little control over crude prices despite its efforts to keep inflation low. Oil prices in recent years have been driven higher by strong demand in the United States and China that has barely been matched by the growth in supplies worldwide because of persistent geopolitical tensions in the Middle East and elsewhere.

The Fed’s rate increases have mostly failed to temper demand among Americans consumers, who use a quarter of the world’s oil supplies primarily to fuel their cars and sport utility vehicles. To the extent that consumers have cut back on spending in response to higher prices and interest rates, it has been in other areas, such as eating out. Consumers also have maintained their spending patterns despite high prices by going deeper into debt — a trend that the Fed also seeks to stop.

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