Federal Reserve Chairman Ben Bernanke said on Tuesday the surge in oil prices is unlikely to hurt the U.S. economy unless it is sustained, even as investors sold off equities on fears of a slowdown.
Bernanke, making his first comments since the turmoil in Libya drove U.S. crude oil above $100 a barrel, said he would expect higher prices to lead to only a modest, temporary increase in U.S. inflation at most.
The Fed chief told the U.S. Senate Banking Committee he saw increasing evidence that the economic recovery has enough momentum to become self-supporting. But job growth remains far too anemic, he said, indicating the Fed was unlikely to cut short its $600 billion bond-buying stimulus.
We do see some grounds for optimism about the job market over the next few quarters, Bernanke said, citing a steep recent decline in the jobless rate among other factors.
Bernanke, who will testify for a second day before a House of Representatives committee on Wednesday, also reiterated a warning that a failure by Congress to raise the U.S. government's $14.3 trillion debt ceiling could lead to a devastating debt default.
It would be extremely dangerous and very likely a recovery-ending event, he said. The U.S. Treasury Department on Tuesday said the debt limit could be reached as early as April 15, 10 days later than its previous estimate.
Bernanke's warning came just hours before the House approved a short-term funding bill that would avert a looming government shutdown and buy time to fashion a longer-term budget. The Senate was expected to quickly take up the measure.
Some Republicans have vowed to use the need to raise the debt ceiling as a lever to push for deep spending cuts.
Bernanke told the panel that downside risks to growth had eased and, for the first time, said the prospect of deflation was now negligible. The threat of deflation, a downward spiral in wages and prices that could derail the economy, was a key justification for the Fed's bond-buying spree.
It's encouraging to see that the risk of deflation is moderating according to the Fed, said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. That's one of the keys that will be necessary for the Fed to wind down its quantitative easing program.
At the same time, Bernanke did not appear concerned that the recent spike in the price of crude oil, driven in part by a wave of pro-democracy revolutions in the Middle East and North Africa, would do much harm to the U.S. economy.
The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation, Bernanke said.
However, he warned that if expectations of future inflation were to build, the Fed may need to act.
We will continue to monitor these developments closely and are prepared to respond as necessary to best support the ongoing recovery in a context of price stability, he said.
U.S. crude oil futures rose 2.7 percent on Tuesday to settle at $99.63 a barrel, not far from highs hit late last month. Crude had traded at roughly $86 a barrel before protests swept through Egypt in late January.
( For graphic on oil's effect on world growth, see http://bit.ly/hsRloR)
Financial markets showed little reaction to Bernanke's comments, but the jump in oil prices weighed on stocks, with the Standard & Poor's 500 index closing down 1.57 percent. Wall Street's so-called fear gauge, the CBOE Volatility Index, jumped 13.1 percent. U.S. government bond prices rose as investors sought safety.
With official interest rates held near zero since December 2008, the Fed in November embarked on a controversial program to buy government debt to keep down long-term interest rates. Bernanke said buoyant financial markets suggest the policy is working, but the labor market still has a long way to go.
In January, the jobless rate stood at 9 percent.
Until we see a sustained period of job creation, we cannot consider the recovery to be truly established, Bernanke said.
MANDATE BATTLE BREWING
Much of the discussion at the hearing centered around Washington's heated budget debate. Bernanke refrained from offering detailed advice on fiscal matters, but urged lawmakers to get the deficit under control.
The long-term imbalances are not just a long-term risk, Bernanke said. They're a near and present danger.
The banking committee's chairman, Democrat Tim Johnson, kicked off the session with a strong defense of the Fed's dual mandate of price stability and maximum sustainable employment.
Some Republicans who have been critical of the Fed's ultra-easy monetary policy have vowed to introduce legislation forcing the central bank to focus solely on inflation.
Johnson suggested that would not be an easy fight.
As the economy continues to struggle to recover, we should be using every tool in the toolbox to create jobs and spur growth, he said in a statement. Taking tools away from the Fed now is the wrong idea at the wrong time.
(Additional reporting by Emily Kaiser, Doug Palmer, Lucia Mutikani and Tim Ahmann; Editing by Tim Ahmann, James Dalgleish and Leslie Adler)