Bernanke Says Rate `Well Positioned,' Watching Dollar
By Scott Lanman
June 3 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke signaled he's done cutting interest rates for now and raised his biggest concerns yet about the inflationary effects of the dollar's 16 percent drop in the past year against the euro.
The Fed is working with the Treasury to ``carefully monitor developments in foreign exchange markets'' and is aware of the effect of the dollar's decline on inflation and price expectations, Bernanke said today in his first speech on the economic outlook in two months. In addition, interest rates are ``well positioned'' to promote growth and stable prices, he said.
Bernanke's comments are a shift from past remarks by Fed officials that have highlighted both the spur to exports from a cheaper dollar and the pressure it puts on import prices. The dollar climbed after the speech indicated exchange rates will be a consideration in setting rates.
``I can't recall such a strong defense of the dollar from a Fed chairman,'' said Sophia Drossos, a currency strategist at Morgan Stanley in New York who used to work at the New York Fed, where she helped manage the central bank's foreign-exchange holdings. ``The Fed is putting its marker down in letting the market know that a weaker dollar would be detrimental.''
Investors anticipate the central bank will keep its benchmark rate at 2 percent this month after 3.25 percentage points of cuts since September, futures prices show.
ECB's Trichet
Bernanke, 54, spoke via satellite to the International Monetary Conference in Barcelona, Spain. European Central Bank President Jean-Claude Trichet also spoke at the event, where he reiterated that ``monetary policy stays firmly focused on delivering price stability.''
``For now, policy seems well positioned to promote moderate growth and price stability over time,'' Bernanke said. ``We will, of course, be watching the evolving situation closely and are prepared to act as needed to meet our dual mandate.''
The remarks come as the central bank's optimism that inflation is abating and growth will start to pick up has been dashed by the unexpected surge in oil prices, which is eroding the potential benefit to the economy from more than $100 billion in federal tax rebates. The resulting increase in inflation expectations is also getting the attention of Fed officials.
The dollar strengthened to $1.5450 per euro from $1.5537 earlier today. Gold dropped 1.3 percent to $879.69 an ounce. Crude oil fell 2.8 percent to $124.15 a barrel.
Fed `Attentive'
``We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations,'' Bernanke said. The Fed's commitment to price stability and maximum employment ``will be key factors ensuring that the dollar remains a strong and stable currency.''
During the dollar's decline over the past six years, some Fed officials have said foreign demand for U.S. assets may fade. Bernanke's predecessor, Alan Greenspan, told a European audience on Nov. 19, 2004, that ``given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point.''
Bernanke and other Fed officials, when asked for their opinion on the dollar, tend to defer to the U.S. Treasury Department, which is responsible for currency policy. The Fed chief meets weekly with Treasury Secretary Henry Paulson, who yesterday repeated his backing for a ``strong dollar.''
``I believe the long-term economic fundamentals will be reflected in our currency,'' Paulson said in Abu Dhabi.
`Financial Stability'
David McCormick, Treasury's undersecretary for international affairs, said in a Bloomberg Television interview today that Bernanke's and Paulson's remarks this week ``are consistent in that they are advocating policies that will strengthen the U.S. economy and ultimately ensure ongoing financial stability within the global markets.''
Asked about the dollar at a congressional hearing Feb. 27, Bernanke at the time noted that its decline ``does increase U.S. competitiveness.'' He also noted its impact on inflation.
Robert Eisenbeis, former head of research at the Atlanta Fed, said the comments indicate ``more rate cuts would hurt the dollar and that would have negative feedback effects to our inflation situation.''
``I don't read it as saying that intervention is on the horizon,'' said Eisenbeis, who is now chief monetary economist at Cumberland Advisors Inc. U.S. officials haven't intervened in foreign-exchange markets to buy or sell the dollar since President George W. Bush took office in January 2001.
`Significant Headwinds'
Today, Bernanke said financial-market conditions ``remain strained,'' and consumers face ``significant headwinds'' from declining home prices, a weaker labor market, stricter lending standards and higher energy costs.
The U.S. economy grew at an annualized 0.9 percent pace in the first quarter, capping the weakest six-month performance in five years, government figures showed last week.
The second quarter is ``likely to be relatively weak,'' Bernanke said, leaving out his mention in an April speech of a possible contraction. The second half may have ``somewhat better economic conditions,'' and growth may pick up further in 2009, he said.
``Until the housing market, and particularly house prices, shows clearer signs of stabilization, growth risks will remain to the downside,'' Bernanke said. ``Recent increases in oil prices pose additional downside risks to growth.''
Supply and Demand
Bernanke, in a question-and-answer period, said soaring oil costs are more the result of supply and demand than the weaker dollar. ``The effect of the dollar on commodity prices is relatively modest,'' he said. Supply and demand conditions are ``by far the strongest and most important factor.''
Crude oil has climbed 93 percent in the past year. Gasoline prices have also hit a record, impairing spending by consumers who are already buffeted by a slump in home values.
``The possibility that commodity prices will continue to rise is an important risk to the inflation forecast,'' Bernanke said. Higher public inflation expectations are also a ``significant upside risk'' to prices and may ``ultimately become self-confirming,'' he said.
