Federal Reserve chief's stagflation scare

June 6, 2006

U.S. Federal Reserve Chairman Ben S. Bernanke has told an International Monetary Conference inflation is creeping higher and will receive "particular scrutiny."



Benanke's comments, to an audience of bankers at the Willard Hotel in Washington, has tripped up stocks and bonds which fell by 199 points on US markets Monday (1.8 per cent loss).

The comments seem to have been interpreted by traders to mean there will be an interest rate rise.

A strategist at Wells Capital Management said: "Here we have some suspicion the economy may be weakening ... and a struggling stock market," "And the Fed chairman chooses [Monday] to inform everyone he has decided to get tough on inflation," says Jim Paulsen.

The panicked markets had expected no rate rise at the next Federal Reserve meeting on June 29. The United States central bank began raising interest rates two years ago - 16 consecutive rises later it stands at 5%.

The news might also suggest the billowing crude and commodity markets have affected other parts of the economy. Excluding energy or food prices, core inflation was "at or above the upper end of the range that many economists, including myself, would consider consistent with price stability," Mr Bernanke said.

Bernanke said his core inflation canal was between 1% and 2% a year. Quarter inflation, however, was rising: 3% through six months; 2.3% over 12 months. "These are unwelcome developments," Bernanke said when he announced the figures.

Overall the economic data was "consistent with the softening in the pace of overall economic activity that seems to be under way," Bernanke said in his speech. Stagflation is the economic problem of rising inflation and falling growth. The Federal Reserve often lower interest rates to finance the economy but in an inflationary economy interest rates might also need to rise. Such a situation might put the Fed in an uncomfortable pinch.

Monetary policy is an incomplete science. Even so, Bernanke is old enough to remember the 1970s when the Federal Reserve declined an interest rate rise. Recession and high prices appeared to be the result.