Bernanke Plays `Dangerous Game' Balancing Rate Talk With Action

By Scott Lanman

June 24 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke, by voicing concern about inflation and the slumping dollar, has fanned investor expectations for an interest-rate increase as soon as August. He may regret it.

Raising rates may exacerbate the economic slowdown and roil banks whose losses sent their stocks down the most in a decade this month. Forgoing a rate boost next quarter risks damaging the Fed's credibility and deepening its divisions. Already this year, three officials have dissented on rate decisions.

While Bernanke's warning that the Fed will ``strongly resist'' a jump in inflation expectations led traders to bet on a rate increase, economists are more skeptical. All 101 in a Bloomberg News survey said the Federal Open Market Committee will keep the benchmark rate unchanged tomorrow and most analysts this month predicted officials will stand pat until 2009.

``That's the dangerous game,'' said Scott Anderson, senior economist in Minneapolis at Wells Fargo & Co., the fourth- largest U.S. bank by market value. ``Instead of putting the shot across the bow on inflation,'' Bernanke might have ``held off a few more months to let the credit crisis heal a little bit more.''

The Fed chief shifted stance after soaring costs of energy and imported goods threatened to stoke consumer price expectations. Gasoline climbed 37 percent in the past year, according to AAA. Import prices excluding petroleum rose the most since 1988 in the 12 months to May, government figures show.

Bernanke's Message

Bernanke said at a Boston Fed conference June 9 the risk of a ``substantial downturn'' in the economy had diminished and accelerating inflation ``would be destabilizing for growth.'' The previous week, he said the falling dollar caused an ``unwelcome'' increase in domestic prices and the Fed was ``attentive'' to the problem.

There are widespread expectations among traders for a rate rise in the next three months: There are 36 percent odds of a boost in August and 93 percent in September, according to futures contracts on the Chicago Board of Trade. Economists in a monthly Bloomberg survey through June 11 projected the Fed will keep the rate at 2 percent this year, according to the median estimate.

The FOMC begins gathering today in Washington and will issue its statement tomorrow around 2:15 p.m.

`No Bite'

``Unless the inflation expectations and the numbers come down, they're going to have to raise rates,'' William Ford, a former Atlanta Fed chief who's now at Middle Tennessee State University in Murfreesboro, said in a Bloomberg Radio interview. ``If he's saying we're going to fight inflation but he's all bark and no bite, division is what's going to happen.''

Dallas Fed President Richard Fisher, Philadelphia Fed chief Charles Plosser and William Poole, who retired from the St. Louis Fed in March, dissented on rate decisions this year.

The FOMC usually has seven Fed board members and five district-bank heads. Two board positions are now vacant, and a third opens in August with Governor Frederic Mishkin's departure.

That means the presidents, who tend to dissent more than governors, may get a majority. The Senate has yet to confirm the Bush administration's board nominees, though Democratic Senator Christopher Dodd of Connecticut, who chairs the Senate Banking Committee, has said he may hold a vote on at least one of the picks.

Officials are increasingly sounding the alert that they're prepared to raise rates this year.

`Act Preemptively'

``If we don't take action and stay on top of the situation,'' inflation will probably accelerate, James Bullard, Poole's successor, said June 11. Bullard doesn't vote this year. The Fed must ``act preemptively,'' Plosser said June 12.

Consumers anticipate annual inflation of 3.4 percent in the coming five years, a 13-year high, a Reuters/University of Michigan survey showed this month. A measure of price expectations based on 10-year Treasury inflation-protected securities has also risen this year, to 2.46 percent.

A measure of prices tied to consumer spending has averaged annual gains of 3.3 percent so far this year, up from 2.5 percent in 2007. Excluding food and energy costs, the Commerce Department's index has averaged 2 percent increases this year, compared with a 1.8 percent average pace since 1998.

Bernanke has said the slowdown should alleviate price pressures. The economy expanded 0.9 percent in the first quarter, capping the weakest six-month performance in five years.

Bank Losses

The downturn is weakening U.S. banks already struggling with the credit crisis and the worst housing slump in a quarter century.

The Standard & Poor's 500 Banks Index is down 20 percent in June, on course for the worst month since August 1988. More than 100 lenders have been forced to close, halt operations or sell themselves since the beginning of last year.

Fifth Third Bancorp, Ohio's second-biggest bank, said June 18 most of its quarterly profit will evaporate after already posting nine consecutive declines.

``The issue here is whether the Fed is willing to risk an escalation of inflation and then a bigger recession later, or acts earlier, taking a risk of a smaller recession, but preventing inflation from getting out of hand,'' Poole said in a Bloomberg Television interview.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net