US Federal Reserve chairman Ben Bernanke bared his fangs on inflation on Monday with a toughly worded speech that caused market odds on a rate hike this month to jump.
In the speech to a conference here on international monetary policy, the Fed chief said the US economy was clearly flagging but that inflation had risen to "unwelcome" levels that would require vigilance.
He said the US economy "is entering a period of transition" towards lower growth.
But at the same time, because of high energy prices, core inflation rates are on the rise, he said.
Prices have risen to levels that if sustained, "would be at or above the upper end of the range" consistent with stable inflation and long-term economic growth.
Core consumer inflation, excluding energy and food prices, rose 3.2 percent over the past three months.
"These are unwelcome developments," Bernanke said, stressing that Fed policymakers would "be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained."
After recent data signaled weak growth and rising prices, some economists are fretting that the US economy is suffering 1970s-style "stagflation" -- low growth coupled with higher inflation.
This leaves the Fed in a dilemma. Minutes from its May 10 meeting suggested the central bank was uncertain about its future course, having debated the possibility of a pause or a half-point rate hike.
In the end, the Fed raised rates by a quarter-point, its 16th consecutive move. There is intense speculation about what the bank will do when it next meets on June 28 to June 29.
Some market players had begun to question Bernanke's inflation-busting credentials, after he succeeded the long-serving Alan Greenspan in February.
But the speech left more investors betting that the Fed would continue its long-running campaign of hikes. The US dollar rose against major currencies, Treasury yields spiked and share prices accelerated a heavy slump.
"Bernanke made it very clear that, even if there's an economic slowdown, the Fed's number one job is to fight inflation and the market is reacting to that," Cantor Fitzgerald equity analyst Marc Pado said.
On the rate futures market, the odds soared to as high as 75-25 in favor of a hike this month, from an evenly balanced 50-50 before Bernanke's speech.
"He's stressing the inflation angle over growth, that is clear. He's giving explicit guidance to the markets," Wachovia chief economist John Silvia said.
"I can't imagine them not raising rates now," he said.
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