Bernanke Looks Beyond Market Tumult to Focus on Inflation Risks

Federal Reserve Chairman Ben S. Bernanke isn't blinking in his battle against rising prices even as tumult in financial markets threatens to slow growth.

Fed officials said higher inflation is ``the predominant risk'' when they kept their benchmark interest rate at 5.25 percent yesterday. They rebuffed calls for a more balanced assessment that may have presaged a rate cut. In doing so, they also broke with former Chairman Alan Greenspan, who elevated the role of financial market stability in setting policy.

``They see the paramount task as keeping inflation low and keeping inflation expectations anchored,'' said Brian Sack, a former adviser to senior Fed officials on policy strategy who's now an economist at Macroeconomic Advisers LLC in Washington.

Bernanke's unwillingness to budge comes after price increases slowed for four straight months, to the lowest since he took office. The Fed chief emphasizes the institution's forecasts over coming quarters, while Greenspan tended to stress current conditions when markets weakened, enabling rapid shifts in policy.

U.S. stocks lost about $1.26 trillion in market capitalization since benchmark indexes reached records in July as banks restricted credit because of rising defaults on subprime mortgages. Volatility climbed to the highest since April 2003 this week, according to the VIX index, a gauge tied to the S&P 500 index compiled by the Chicago Board Options Exchange.

``The signal from the Fed was unmistakable: turbulent markets, in and of themselves, will not be sufficient to force their hand,'' said Peter Kretzmer, senior economist at Banc of America Securities LLC in New York.

`Baptism of Fire'

The 1987 stock-market crash was Greenspan's ``baptism of Fire,'' he said at a New York exposition June 1. While some advised him to wait to see the impact on the economy from a 23 percent slide in the Dow Jones Industrial Average, Greenspan said he concluded quickly that the U.S. was on the edge of ``fairly pronounced dangerous positions.'' He then said he would provide ``liquidity'' to the banking system.

In 1998, the Greenspan Fed lowered the benchmark rate three times as emerging market turmoil roiled Wall Street, and raised it on three occasions the next year. In January 2001, the Fed enacted an emergency rate cut just seven weeks after saying the risks were ``weighted mainly toward'' inflation pressures.

Bernanke, 53, and his colleagues have kept the federal funds rate unchanged for a year, the longest freeze in nine years.

Futures Trading

Traders yesterday reduced their expectations for a rate cut in the coming two months. Investors see a 58 percent chance the Fed will lower its benchmark rate by the end of October, down from 84 percent the previous day, based on futures on the Chicago Board of Trade. A reduction by year's end is still a certainty, futures indicate.

Unlike Greenspan, Bernanke isn't going to provide short- term financing to help ease a slump in asset prices, said Joe Carson, director of research at Alliance Bernstein LP in New York. It's too early to know if Bernanke's strategy will be successful, he said.

``Wall Street is looking for an easy solution to these problems,'' Carson said. Monetary ``policy is not going to help out.''

At least 70 mortgage firms have halted operations, gone bankrupt or sought buyers since the start of 2006. Large banks are also cutting back on their appetite for risky financings of corporate takeovers. At Bear Stearns Cos., two hedge funds failed in June and the firm's chief financial officer said Aug. 3 that the fixed-income market is in the worst shape in 22 years.

The Fed said yesterday that it still expects a ``moderate'' expansion. Policy makers added that ``solid growth in employment and incomes and a robust global economy'' will help.

Growth Rate

The government said on July 27 that the U.S. economy expanded at a 3.4 percent annual pace in the second quarter, the fastest in more than a year, after a revised gain of 0.6 percent in the three months ending March.

Economists and Fed officials anticipate a slacker expansion in the second half. For the year, Fed governors and presidents expect growth, on average, of about 2.25 percent to 2.5 percent, Bernanke told Congress last month. The projections are about a quarter-point below the previous round in February, mainly because of the weakness in homebuilding.

Price increases have slowed for four straight months under the Fed's preferred gauge, which excludes food and energy costs. The core personal consumption expenditures price index rose 1.9 percent in June after a revised 2 percent gain in May, the Commerce Department said July 31.

Financial volatility did change Fed officials' sense of the risk around the forecast. ``Downside risks have increased somewhat,'' the statement said.

``It is a step away from tightening, it is not a step toward easing,'' said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago. ``Greenspan was more of a tinkerer. Bernanke is `stay the course until you tell me not to.' And the `you' is not the bond market, it is the economy.''

source:bloomberg.com