Federal Reserve Chairman Ben Bernanke told Congress on Wednesday housing market woes could dampen an expected pickup in U.S. economic growth, but he restated that the central bank's main worry is inflation.
Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend, he said in semiannual testimony to the House of Representatives Financial Services Committee.
Bernanke said the drag on growth from a downturn in the U.S. housing market should ease over time, but he said there was a risk the slump could last longer than anticipated, undercutting economic growth.
Financial markets took their cue from Bernanke's assessment of risks stemming from the housing market. Prices for U.S. stocks and the dollar fell, while government bond prices rose.
However, the Fed chief also listed a number of factors that could spark inflation, including a tight job market and the possibility energy prices could move higher.
Their best guess is that growth is moderate and core inflation slows a bit more, but certainly there are risks in both directions, said Jim O'Sullivan, an economist with UBS Warburg in Stamford, Connecticut. The nut of it is the Fed is on hold.
The central bank has held benchmark overnight interest rates steady at 5.25 percent for more than a year in the hope somewhat sluggish economic growth would curb price pressures.
As a result of weaker-than-expected home building, the Fed cut its forecast for growth this year by a quarter-percentage point to a range of 2.25 percent to 2.5 percent, and downgraded its 2008 projection as well.
Still, Bernanke kept true to the Fed's most-recent policy pronouncement in citing inflation as the top concern.
He said a recent moderation in core inflation, while favorable, may be the result of temporary influences.
While the Fed expects core inflation, which strips out volatile food and energy costs, to edge a bit lower, on net over the remainder of this year and next, the Fed chairman said this result was by no means assured.
With the level of resource utilization relatively high and with a sustained moderation in inflation pressures yet to be convincingly demonstrated, the (Fed's policy panel) has consistently stated that upside risks to inflation are its predominant policy concern, he said.
Bernanke said big jumps in food and energy costs had pushed a price gauge closely watched by the Fed -- the so-called PCE price index -- up at a pace that would clearly be inconsistent with the objective of price stability if it were to continue.
A separate inflation measure released just before Bernanke testified -- the U.S. Consumer Price Index -- showed a 0.2 percent increase last month in both overall prices and prices excluding food and energy.
Over the past 12 months, core prices rose 2.2 percent, the same as in May, but the overall index gained 2.7 percent.
Bernanke said falling home-building activity will likely continue to weigh on economic growth over coming quarters, but said the drag should ease over time.
He also said that despite a significant deterioration in the subprime mortgage market, which caters to borrowers with blemished credit, overall financial conditions remain supportive of growth.
Financial markets have shown signs of stress as details have emerged about investment banks' exposure to bad loans, such as Bear Stearns' revelation on Tuesday that two of its hedge funds with extensive subprime bets now have little or no value.
In spite of a widening of credit spreads on lower-quality corporate debt, credit spreads remain near the low end of their historical ranges, and financing activity in the bond and business loan markets has remained fairly brisk, Bernanke said.
At the same time, the Fed chairman deplored what he described as abusive lending practices and outright fraud that had accompanied an expansion of mortgage lending. He promised the Fed would act to rein in questionable practices.
Rising delinquencies are creating personal, economic, and social distress for many homeowners and communities -- problems that likely will get worse before they get better, he warned.