by craig torres & scott lanman
Aug. 22 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said inflation should ease later this year and in 2009, while warning that policy makers will act if price increases don't slow over the ``medium term.''
A recovery in the dollar and declines in commodity prices ``should lead inflation to moderate,'' Bernanke said in a speech to the annual Fed conference in Jackson Hole, Wyoming today. The Fed ``is committed to achieving medium-term price stability and will act as necessary to obtain that objective,'' he said.
The Fed chief said the benchmark interest rate is ``relatively low'' given an increase in price pressures. Financial turmoil has ``not yet subsided,'' and is contributing to weaker economic growth and higher unemployment, he said.
Bernanke said that as the central bank deals with the current turmoil, officials must also consider how to overhaul regulations to minimize the risk of future crises. He reiterated his endorsement of the Treasury getting power to resolve failing investment banks, and signaled a need for a new, comprehensive supervision of systemic risk.
Policy makers will ``continue to review'' the Fed's measures to ensure liquidity to determine ``if they are having their intended effects,'' Bernanke said. He also called for stronger trading settlement systems for derivatives and the so-called tri- party repo market that investment banks have relied on for financing.
Bernanke's comments on inflation follow government figures last week that showed consumer prices climbed the most in 17 years in the 12 months to July, propelled by energy and food costs.
Futures Trading
Traders added to bets that the Fed will increase borrowing costs by the end of the year, futures prices show. Odds of at least a quarter point boost in the main rate by the end of December rose to 32 percent from 18 percent yesterday. The highest probability is that the Federal Open Market Committee keeps the rate at 2 percent until next year, the contracts show.
Bernanke ``seems really comfortable with where policy is right now,'' saidJohn Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina. ``The challenge is how patient is the Fed going to be.''
The Standard & Poor's 500 Index advanced 1.1 percent, to 1,292.20 at the close in New York. The dollar climbed 0.7 percent to $1.4793 per euro. Gold lost $14 to $823.05, while two-year Treasury notes slid, sending their yields up to 2.41 percent, from 2.31 percent.
`Severe' Disruptions
In his speech to the Kansas City Fed Bank's two-day conference on financial stability, Bernanke again defended the Fed's role in keeping Bear Stearns Cos.from collapse, and said ``the economy could hardly have remained immune from such severe financial disruptions.''
Former Fed Chairman Paul Volcker and other ex-central bankers have warned in recent months that the Bear Stearns rescue will encourage investors to take on excessive risk and set the stage for bigger bailouts.
``Where can the limits be drawn?'' Volcker, the Fed chairman from 1979 until 1987, said June 9. The following month, the Fed opened up discount window lending to Fannie Mae and Freddie Mac to revive confidence in the two largest U.S. mortgage finance companies.
The Fed chairman has tried for the past year to curb a global credit crisis that has led to a higher U.S. jobless rate, slower economic growth and some $505 billion in credit losses at financial firms.
Fed Powers
Bernanke asked Congress to give the Fed more authority over the U.S. payments system, and to consider devising a way to resolve failing investment banks. He also said regulators must shift their focus and consider how individual banks and brokers may together present large risks to the financial system.
``Making the systemic risk rationale for guidances and reviews'' of financial firms ``more explicit is certainly feasible and would be a useful step toward a more systemic orientation for financial regulation and supervision,'' Bernanke, 54, said to the conference of scholars and central bankers.
Bernanke also called for ``stress tests, not at the firm level as occurs now, but for a range of firms and markets simultaneously.'' Such exams might ``reveal important interactions that are missed by stress tests at the level of the individual firm.'' He said the technical and information requirements regulators need to conduct such tests ``could be daunting.''
No `Illusions'
``It is very clear that he is not under any illusions that this is over,'' Princeton University professor and former Fed Vice Chairman Alan Blinder said in a Bloomberg Television interview in Jackson Hole after Bernanke's speech. The chairman suggested that ``the Fed in particular ought to be thinking more about regulation that is systemic in nature'' rather than focusing only on the health of banks, he said.
The Fed has opened up lending to nonbanks for the first time since the Great Depression, accepted mortgage debt as collateral for loans and cut the interest rate on its discount window lending. The measures have broadened the Fed's oversight and lender-of-last resort role.
Bernanke opened the discount window to investment banks in March after rescuing Bear Stearns Cos. from bankruptcy. The Fed facilitated the firm's merger with JPMorgan Chase & Co. by loaning against $29 billion of Bear securities. It opened the discount window in July to Fannie Mae and Freddie Mac, the largest U.S. mortgage finance companies.
Derivatives Trading
To limit the damage from any future failure of a securities dealer, the Fed has pressed firms to standardize trading and settlement practices in derivatives and tri-party repo markets.
``A migration of derivatives trading toward more- standardized instruments and the increased use of well-managed central counterparties, either linked to or independent of exchanges, could have a systemic benefit,'' Bernanke said today.
Bernanke also said the Fed is encouraging firms to reduce their reliance on tri-party repos for overnight financing, the type of short-dated credit that can dry up quickly if counterparties lose confidence.
``We should also explore possible means of reducing this market's dependence on large amounts of intraday credit from banks,'' the Fed chief said. That could be aided by introducing a ``central counterparty,'' he added.
To contact the reporter on this story: Craig Torres in Washington atctorres3@bloomberg.netScott Lanman in Washington atslanman@bloomberg.net
